The Economics of Uber

ESSA ADMIN

Aug 19, 2014 • 3 min read

Uber is a mobile application which connects passengers to willing, private drivers who pick them up and drive them where they need to go, much like a taxi service. Uber itself earns revenue by taking a 20% cut of fare cost. Currently, Uber is making headlines for various legal issues regarding the ethics of its practice, however what I find truly fascinating about Uber is its vivid display of many microeconomic principles. Often our studies of economics at university focus purely on ideas, whereas Uber is intriguing because it exhibits these ideas and showcases their relevance.

For years now, in much of the western world, including Australia, the taxi market has represented some form of monopoly, duopoly or oligopoly power. For example, in Victoria, the taxi industry has been dominated by two services; 13 Cabs and Silvertop Taxis. In order to own a taxi plate you would have to purchase an expensive license between $300,000-$500,000 and register with one of these companies to become a supplier of a taxi service. These market features are of course expected as microeconomics teaches us monopolies and duopolies are characterised by their high barriers to entry. Furthermore, given the exorbitant fees charged by taxis in the western world compared to that of Asian countries, it is clear to see that prices charged are far from the perfect competition condition where price is equal to marginal cost.

Legal or not, Uber’s entrance into the taxi market has sidestepped many of these barriers. Now, without purchasing a license anyone can become a supplier of Uber’s taxi service, and as such this has introduced a great influx of taxi services. The operation of this kick-starter app has in fact reformed the entry barriers into taxi markets throughout many Western countries. This is most clearly exemplified in the parallel emergence of Lyft, another start up based on similar principles. Just like Uber, Lyft allows anyone to become a taxi driver and much like Uber it has generated incredible popularity. So within the space of a year the taxi market underwent a huge change, from one with extreme boundaries, to one with almost none. Furthermore, if we delve into the behaviour of both these companies it can be seen that they are constantly ‘undercutting each other’s prices, poaching drivers, co-opting innovations and increasingly blurring the lines between the two services’. This is an example in game theory called the Bertrand game, where two firms are constantly bidding prices down in order to attract market share until they reach the zero economic profit condition. Furthermore, as more companies begin to enter this taxi market such as Ingogo we can even see more characteristics of perfect competition emerging. For example Macmillan suggests that Uber, Lyft, TaxiMagic, SideCard, continue to imitate each other’s features, which we can identify as homogeneity of services, a fundamental tenet of perfect competition.

Another key feature of Uber which has intrigued economists is the concept of price surging. Uber’s business model represents one of the most basic principles of economics: increased demand raises prices and allows supply to expand. One example of this is during a snowstorm in New York in December 2013. The road conditions were terrible and there was a deficit of usual yellow taxis, leaving many stranded. In this instance Uber increased its fares up to six fold. While many customers have labelled this as ‘price gouging’, it achieved its intended effect of incentivising drivers to hit the roads and meet the demand willing to pay these prices. This phenomenon is so intriguing because unlike many markets, demand and supply adjustments are made instantaneously. Although this is not a perfect bidding market, but rather algorithm based pricing, it still fascinating to see information immediately reflected in prices.

Overall, the case of Uber is truly a fascinating one from an economic standpoint. It showcases the power increasing technology has in transforming markets and equipping consumers and suppliers with information. Perhaps the most incredible aspect is the fact that in the case of Uber these economic concepts and changes appear quickly right in front of our eyes.

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