I. What happened
Uber is a well-known app providing ride-hailing services, with businesses operating around the world. It is a rather new business model – “the sharing economy” which matches up taxi passengers and drivers. In India before 2016 when price used to be unregulated, as opposed to the traditional taxi service providers mandated to charge fares below a certain threshold, Uber was free to set its price based on its dynamic pricing mechanism that could automatically adjust the price according to real-time demand and supply in a locality. At peak hours, Uber’s fare could jump several times the regular rate. Such jumps concerned the Karnataka government of India.
II. Price ceiling
The Karnataka government imposed a price ceiling on app-based taxi services including Uber, which mandated that air-conditioned cabs and non-air-conditioned cabs will be not able to charge more than Rs 19.50 and Rs 14.5 per kilometre respectively. The policy was intended to ensure competitive fares between online and offline taxi players by restricting the pricing of all players in the market. The policy did not mean a ban on surge pricing of Uber entirely, but merely a ceiling. Compared to Uber’s cheapest service starting at Rs 7/km at that time, the cap still allowed the company to raise fares almost 3 times higher.
As the price went down, more passengers who once deemed Uber’s services too costly wanted to ride out, but fewer drivers were incentivized to provide their services because of a lower return. The outcome was that passengers needed to wait longer to get a Uber. The winner would likely be those with patience and lower time cost, while those who did not want to wait might take alternatives like walking, taking a bus or metro. As a result, fewer people could get Uber’s services, whereas those who had the service benefited from cheaper fares.
Economic theories tell us that a price ceiling may not be beneficial to consumers. Let’s assume the Uber pricing mechanism could always set at a market-clearing price where the quantity demanded is equal to the quantity supplied. First of all, the price cut of Uber services means a drop of quantity supplied which will lead to a shortage in the market. That means some passengers willing to take a cap now fail to find any. Besides, some passengers, who are willing to pay a higher price and would have otherwise gotten the service under no price ceiling, can no longer get the service by bidding up the price. They are forced to compete in non-price forms like patience.
A price ceiling could not eliminate the scarcity of goods and services. The demand for Uber services still exists and buyers have to compete for it in other forms. In case of a shortage when price competition is forbidden, non-price rationing becomes an alternative method for resource allocation. Relationship, social class, violence and patience some alternative criteria for rationing. Take relationships as an example. Recognizing there are tons of consumers waiting for an Uber, drivers may want to prioritize the calls of relatives or close friends, leaving the ordinary consumers less chance of getting a cab.
While drivers are not allowed to adjust the price, they can always cut costs in other aspects. The price ceiling leads to a deterioration of quality. For example, although those who manage to get a cab could enjoy a lower price, free tissue provided before may be gone and the interior of the cab may not be as clean as before. The costs saved by cutting the free tissue and reducing the cleaning frequency are used to compensate for the reduction in fare.
The price ceiling will also decrease long run supply. Entrepreneur will devote themselves to a project that could generate the highest return. The price ceiling dampens the profitability. More entrepreneurs will shift to alternative investments. In the case of Uber in India, they may want to buy a truck to provide delivery services without a price cap rather than buying a private car to be an Uber driver. As a result, the supply of Uber will decrease in the long run.