In Defense of Surge Pricing

As 2014 ends, prognosticators are busy making predictions for 2015. Perhaps the earliest controversy of the new year will concern Uber’s surge pricing on New Year’s Eve. Politicians use such occasions to call for laws to ban the practice of charging higher fares at times of peak demand. But surge pricing confers many benefits for reasons that provide a refresher in how basic economics should make us suspicious of political intervention in markets.

First, surge pricing is more likely to match scarce Uber drivers with riders who value their services most highly. At lower prices, the number of riders would exceed the number of drivers, and some people would be left without a ride, even if they were willing to pay a higher fare.

People with higher incomes are more likely to be among those willing to pay more for Uber’s transportation services, but this is not unique to this market. Wealthier people can generally pay more for what they want. Forbidding surge pricing for transportation will not reduce income inequality. If such inequality is a concern, progressive income taxes and transfers are more direct and would allow people of more modest means to pay more for the services they most desire.

But the allocative benefit of surge pricing, directing scarce resources to their most valuable use, is static. Surge pricing also has dynamic benefits by increasing the supply of drivers. In the short term, drivers who already work for Uber may decide to work on New Year’s Eve. (This is technically an increase in the quantity of transportation services supplied.)  To the extent that they do so, Uber prices will not surge as high as they otherwise might. Over the longer term, more drivers may sign up for Uber, if they can work for higher prices. This will also help mediate any surge in prices in the longer run.

Given that surge pricing provides such benefits, why it is under attack? Politicians think they can grandstand and appear to be champions of the little guy. But they can only do so because of public ignorance. There are two sources of public ignorance. One is rational and it nicely captured by Ilya Somin: People do not invest enough in time and effort in public policy because their vote won’t make any difference to electoral outcomes and they have better uses of their time.

Another argument also seems to apply to surge pricing. Bryan Caplan argues that people have irrational, systematic biases that they have few incentives to correct and one of them is to underestimate the benefits of the market, like surge pricing.

But over time people can often be persuaded of the benefits of a practice if its good consequences become patent enough. In a world where new information technology allows us to make better use of underused resources, like empty passenger seats or spare rooms, and better allows us to estimate demand at different times and place, differential pricing will become accepted as the new normal.