All Commentary
Wednesday, January 14, 2015

In Defense of Uber’s Surge Pricing

Making the best of a bad situation

The smartphone-coordinated ride-sharing company Uber has come under fire for charging “outrageous” prices during peak demand times. I will defend the general principle of “surge pricing,” which performs the vital social function of drawing forth supply when it’s needed and allocating it to those who desire it the most. The complaints against surge pricing are actually laments against the cosmic fact of scarcity. Surge pricing makes the best of a bad situation.

Before proceeding to the economics, I want to be clear that I have not personally used Uber and I am not defending the company’s particular tactics. There are a number of Uber horror stories floating around the Internet, including that of a Denver man Uber reportedly charged $539 for an 18-mile ride on Halloween. The problem I have with this story is not the price per se, but rather that the man claims he had no idea it would be that high, and that even his driver was shocked at the final tally that his phone reported at the end of the ride, saying, “This can’t be right.” Assuming this story (and others like it) are accurate, at the very least, Uber should do a better job of making its new customers aware of such possibilities before they start their journey.

Without endorsing the particular implementation of Uber’s policies, I do want to defend the general principle of dynamic pricing, where the charge for “the same” trip can change based on the number of people requesting rides and the number of drivers willing to pick them up. This is simply supply and demand at work.

An unusually high price means that there is an unusually high demand for rides relative to the supply of drivers. The market price is a signal that succinctly communicates crucial information to everybody involved. To get mad at the market price is as irrational and counterproductive as getting mad at Apple for creating an iPhone that displays the price.

The somewhat decentralized nature of Uber should make it easier to see that the market-clearing price balances the desires of the various people interacting in the market for rides. On a busy night like Halloween or New Year’s Eve, there are large numbers of people who have been drinking and would prefer to pay for a convenient, personalized car ride home rather than risk driving. At the same time, most people would prefer not to spend hours driving other people around on these nights, either, because of the increased danger on the roads and because they might prefer to participate in the festivities rather than work.

The obvious way to alleviate this imbalance is to let the potential passengers offer the potential drivers more money. There is nothing “icky” or “unconscionable” about paying money, after all; nobody expects the Uber drivers to ferry people around town for free. So if people understand the principle of a certain ride having a market price of (say) $10 on a normal day, they shouldn’t balk at that “same ride” having a price of (say) $40 on a busy party night. (To repeat myself, I am only defending the idea of surge pricing in the abstract; if a customer truly wasn’t made aware of the price, that is a different story.)

In a sensible world, the fact that Uber is relatively new would check any criticisms about its “unconscionable” fares. Nobody is forced to hop in an Uber-coordinated car on Halloween night, after all. People can still drive themselves (hopefully with a designated driver), take public transit, call a conventional cab, walk, or stay in a nearby hotel. Some might object that these options aren’t available to all potential travelers on a busy night, but making those options more available is exactly the social function of surge pricing.

For example, if 100 people want to get from the bars on a popular downtown strip back to their homes at 3:00 a.m. but there are only 20 conventional cabbies waiting on the street, people are going to either pile into the cabs and make multiple stops — which I’ve personally seen the police prevent in New Jersey — or they’re going to have to wait a long time on the street for more cabs to show up. A network like Uber’s creates a very elastic supply of potential drivers who can be enticed into service as needed, particularly if the demand for rides is easily forecasted (because it’s Halloween, for example).

The wonderful thing about our smartphone age is that the dynamic pricing isn’t merely limited to a particular night, but can vary even in half-hour intervals. For example, Uber emailed its users on the morning of December 31 warning them to expect high prices from 12:30 a.m. through 2:30 a.m. It advised people to catch a ride as soon as the ball dropped, or to plan on staying out much later. In this way, people could spread their ride demands out according to their willingness to pay: the people with flexible plans could make way for those who (say) had babysitters they needed to get home to by 1:00 a.m., or for those who really didn’t want to leave right at midnight and were willing to pay extra to leave at their preferred time.

The benefits of surge pricing don’t just apply to car rides. We see the same phenomenon whenever there is a blizzard or flood and the prices of bottled water, canned goods, and batteries shoot through the roof. Consumers in the affected region naturally cry foul, but these unusually high prices are necessary to “ration” the available quantities to the people in need. For example, at regular prices, when the news announced an oncoming blizzard, the first few families to get to the convenience store would clean out the shelves. But if prices jump to several times the usual level, people will be much choosier, leaving bottles of water and other items for the customers who show up later. Furthermore, the high prices will give an extra incentive for people in the surrounding regions to figure out how to deliver more supplies as quickly as possible.

Unfortunately, in many areas, there are laws against — or at least vague threats of ex post government action against — “price gouging.” Such threats disrupt the socially beneficial surge in prices and lead to shortages for people in need.

Prices are merely signals summarizing crucial facts about supply and demand, allowing people in the market to coordinate their voluntary interactions with each other. The high price of an Uber ride on Halloween and at other popular times is necessary to balance the heavy demand against limited supply. Ironically, it is Uber’s ability to charge and keep these “outrageous” prices that will attract more drivers and competing ride-sharing organizations into the industry, alleviating the fundamental problem of more passengers wanting rides than there are cars to go around.

  • Robert P. Murphy is senior economist at the Independent Energy Institute, a research assistant professor with the Free Market Institute at Texas Tech University, and a Research Fellow at the Independent Institute.