It’s been 237 years since Adam Smith published The Wealth of Nations, the Bible of modern economics, yet it seems some of its basic lessons have yet to sink in. Unfortunately, knowledge of demand curves, the role of prices in an economy, factors affecting price, and the way entrepreneurs think are all tossed out in the reasoning of well-meaning but poorly informed do-gooders.
In a recent Gawker sub-blog “ValleyWag,” one misguided blogger, in a fit of economic misunderstanding, expressed concern over Uber Taxi‘s recent (and temporary) price surge during inclement weather conditions.
The author reverts to a worn and weary fallacy that bears refutation:
“If more drivers leave traditional taxi companies for Uber—and I’ve talked to many who have—we step closer to cities where price gouging is the norm, where only the rich can get around, and where outrageous profiteering is the base fare. And if you don’t like it, you can hit the road.”
Uber’s justification for the price increase is that fewer drivers want to drive in bad weather, so by charging passengers more for rides in inclement weather, the company is able to pay their drivers more. The company argues that the increase is fair, considering that no one is required to use their service. In bad weather, more people are inclined towards Uber’s services, and Uber wants to increase their supply in congruence with the public demand for their service—it’s basic economics.
But you regularly see the same type of argument made against big-box retailers, particularly when disaster strikes part of country. If we let them do this all the time, the argument goes, big box companies will drive prices up forever!
Are these arguments even reasonable? Is it really more profitable for Uber to gauge all the time? Probably not—because of a few lessons from basic economics.
1.) Demand curves slope downward!
As price increases, quantity demanded decreases. If goods are too expensive, consumers will either stop consuming, or they’ll find an alternative. So even if you assume—as our blogger friend rashly does—that Uber will achieve a monopoly, Uber would still have limits to what they could charge, and they have incentives to keep prices at a rate attractive to consumers.
2.) Substitute goods affect price.
Rephrased, Coca-Cola can only raise their price to a certain point before people start buying Great Value “Cola.” Contrary to our friend the Anti-Uber-Enthusiast, there are currently alternatives to Uber—and they aren’t the “endangered” traditional yellow cabs. The whimsically mustachioed Lyft taxies are prevalent in many areas. In fact, it’s considered a low-cost alternative to Uber. If Uber raises its prices too high for too long, consumers will quickly learn to take Lyft. Free markets tend to provide alternatives.
3.) A free market finds a price for us.
What exactly is the right price for an Uber cab? How much is fair? These aren’t things we can just see. When people are free to make decisions for themselves (i.e. absent price gauging laws) the market discovers prices. That’s equilibrium. If you don’t want to pay 9 times the regular rate for a cab in a snowstorm, you don’t have to pay it, and Uber will suffer the lost business and lost demand. If enough people do that, Uber will lower prices or go out of business. That’s equilibrium. Without a market-set price, when demand increases in a snow storm, no Uber drivers will want to come get you.
4.) Price-gouging often doesn’t make sense.
In markets, reputations and relationships matter. If someone takes advantage of my misfortune to make a profit, I won’t do business with them in the future. Our dear blogger suggests Uber’s price surge could just be “an Ayn Randian CEO fleecing the rich.” But Rand’s characters aren’t price gougers. When Dagny Taggart is building the John Galt Line in Atlas Shrugged, Hank Rearden has a perfect opportunity to gouge prices when he’s the only supplier that can get her the metal she needs on time, but Hank doesn’t. Hank realizes, as most good entrepreneurs do, that relationships and reputations matter.
So why don’t we let the market—Uber and its passengers—set the prices. Unless we want the “Weekend that Uber Tried to Rip Everyone Off” to become “the weekend I had to walk home in the snow because Uber shut down.”
Image via Oliver Fluck
Edit: The sentence “As price increases, demand decreases” was changed to “As price increases, quantity demanded decreases”