New Study Tests the Merits of Surge Pricing

By Matt Kelly

As Uber, Lyft and other “ridesharing” services continue to revolutionize the urban transportation landscape, more complaints are surfacing questioning the efficiency and fairness of the innovative services they provide. One of the more recent is “surge pricing,” the idea that services provided during peak periods carry a higher charge or fee.

A new study by Princeton economist Dr. Henry Farber, titled “Why You Can’t Find a Taxi in The Rain,” could have an important impact on the this debate. Farber’s study could help policy-makers and the general public more fully understand the economic behavior of taxi drivers.

Past research suggested that taxi drivers target a certain level of earnings and then adjust their hours accordingly. If a taxi driver wanted to earn $250 in a 12 hour shift, for example, she would work until she reached the target and then take the rest of the shift off even if they could earn more money by working longer hours and making more trips. This is what economists call “reference dependence” and reflects a “negative wage elasticity of labor supply”–it would seem taxi drivers paradoxically work fewer hours even as wages increase.

In some ways, this makes sense. Why work after 12PM when I’ve already earned the amount of money I expected to make by 6PM? However, reference dependence contradicts established economic theory, which generally predicts workers will work more if wages increase. A small academic literature has emerged that supports the idea of reference dependence and negative elasticity for drivers’ labor supply. (See here, andhere)

Farber’s study challenges these claims. By using a much larger data set than previous studies and introducing a number of variables that help detect and account for other factors affecting drivers’ behavior, Farber estimates more reliable, detailed results. He finds no evidence of negative wage elasticity of labor supply and instead finds a positive elasticity; suggesting taxi driver behavior is consistent with a traditional economic theory: they work more as wages rise.

How does this study relate to the Uber and ridesharing debate?

Surge pricing is intended to increase wages to attract more drivers to an area with high demand. Reference dependent drivers would then reach their target earnings much faster and thus end their shifts prematurely. This could reduce supply and drive the fare price even higher!

Farber’s results, however, suggest that taxi drivers will work more when surge pricing is used, and thus more taxi service will be available at periods of peak demand. This is good news for Uber’s drivers and customers. Surge pricing won’t reduce supply, but rather will attract more drivers to an area with high demand, helping them find better-paying customers while customers enjoy quicker pick-ups.

Surge pricing will likely remain controversial, but policy makers should note its merits in connecting supply with demand more efficiently. Market pricing for taxis and other transportation services could greatly improve efficiency in a 21st century transit system, helping taxi passengers to stay dry and out of the rain.

About DeVoe Moore Center

The DeVoe L. Moore Center is conducts economic research and policy analysis focused on state and local policy issues and is located in the College of Social Sciences and Public Policy at Florida State University in Tallahassee. As an educational institution the DMC provides professional research experience to undergraduate and master’s students through an extensive program of internships and independent study, preparing them for a future in public policy, economic development, public sector accountability and entrepreneurship.
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