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Is Uber’s surge pricing fair?

The ride-sharing service Uber has, once again, been getting some bad press coverage over its surge pricing. The latest outrage occurred when Uber quadrupled its prices due to a surge in demand in central Sydney. The cause of that surge? A hostage siege was unfolding in a Lindt chocolate shop in Sydney’s central business district and people wanted to get out of there, fast.

Though Uber backed down when it realized that this was a mistake, once again, Uber’s surge pricing was called into question. Is it right for companies to engage in what some call “price gouging?”

Specifically, should CEO Travis Kalanick consider “fairness” when making Uber’s business decisions?

The answer is yes, but it’s complicated.

That’s because whereas policymakers look at their choices through two lenses, one that focuses on efficiency and one that focuses on fairness, businesses tend to have one goal in mind: Will the decision maximize profits?

Policymakers take a different approach.  First, they figure out whether there’s a reason for the government to intervene, such as to fix a market failure. Classic textbook examples of market failures are negative externalities, such as pollution and drunk driving, or positive externalities, such as education.

This analysis has nothing to do with fairness. The policy maker simply wants to get rid of the market failure in the most efficient way possible. It can do this with taxes, quotas, price ceilings, and so forth.

Would surge pricing qualify as a market failure calling for government intervention?

It depends, which brings fairness into play.

Fairness becomes an issue when the policy maker begins to take into consideration who will benefit and who will be hurt by the policy.

When Uber engages in surge pricing, it’s simply a response to an imbalance between supply and demand. As Uber explains, when demand suddenly increases, Uber raises the prices for a ride as a way to get more drivers, i.e., supply, on the road. No need for anyone to figure out what price will work because if prices are too high, demand will fall, whereas if prices are too low then supply will fall. At some point, the invisible hand of the market gets the prices just right so that there are enough Uber drivers to take riders where they want to go.

Economists might say there’s nothing wrong because that’s how markets work. Matthew Feeney at the Cato Institute, for example, recently wrote a vigorous defense of the economics of Uber’s surge pricing.

Others, however, find surge pricing distasteful. For example, many were outraged when Uber quadrupled the fare for rides from the Lindt chocolate shop that was under siege, believing that it was immoral for the company to profit from the distress of others.

Similar objections, but with less outrage, arose last fall when a woman who was charged several hundred dollars for a ride on her birthday felt it should have cost significantly less. Others, however, said that it was her fault for accepting the surge price, which Uber requires people to do before sending the driver over.

Far fewer objections arise when Uber introduces surge pricing to get people home from late-night activities, such as bar crawling or concerts.

Many, in fact, appreciate Uber for keeping drunk drivers off the road. Mothers Against Drunk Driving is one of those. It’s created a partnership with Uber via #UberMADD on Twitter to get drunk drivers off the road during certain holidays that experience high levels of drunk driving.

In Uber’s case, fairness aside, surge pricing is designed to bring out enough supply to meet demand. Economists might call this type of pricing “compensating differentials.” When conditions are bad — snowy, late at night, rush hour New Year’s Eve — then people need to be paid more as compensation for the undesirable aspects of the job. There doesn’t seem to be a problem with allowing the market to make these decisions.

But, there are times when governments do step in and restrict price increases. Here, the classic case is after a bad storm. When Hurricane Sandy roared up the east coast a couple of years ago, the government prevented certain businesses from imposing surge prices (they referred to it as price gouging) in the name of “public policy.” To many, it didn’t seem right that gas station owners, for example, should “profit” on the backs of people’s misery. Some businesses were later fined for having engaged in price gouging.

After noting that New Jersey residents’ turmoil was made “worse when companies illegally gouged them for essential items such as shelter and fuel,” New Jersey’s Acting Attorney General said that the government “simply will not allow businesses to victimize vulnerable residents, who already are suffering hardships during a declared state of emergency.”

People reacted the same way with Uber’s price surges during the Sydney hostage siege. Uber sort of apologized, saying that its algorithm automatically sets a surge price when demand peaks, and gave people in this zone a free ride out (Uber paid the drivers the surge fee.).

Uber faced a similar problem with surge pricing after Hurricane Sandy, later agreeing to pay drivers the surge price but to charge riders only the normal fare. In its blog, Uber indicated, however, that the agreement cost Uber more than $100,000 in extra payments and that “footing the bill for higher driver costs” is something that “can’t continue indefinitely without breaking the bank.”

The fact that a business doesn’t always pursue the profit motive isn’t all that unusual. Sometimes, a ruthless pursuit of profits can backfire.

Moreover, there’s academic evidence that employers take fairness into account when setting their prices. A survey of consumer views of fairness in pricing described in a paper co-written by Nobel prize winning economist Daniel Kahneman showed that consumers didn’t mind price increases that were justified by increased costs. But, they did object to price increases they saw as unfair, such as after a storm. In these cases, the authors concluded, firms didn’t take advantage of adverse market conditions to maximize profits by gouging their consumers.

By limiting surge pricing after natural disasters or in perilous situations like in Sydney, policymakers (and companies) do take fairness into account.

Sometimes, a “fair” policy favors the consumer, and sometimes it favors the producer. If the government limits surge pricing, then it is implicitly favoring Uber’s consumers over its drivers.

Whether limiting surge prices is fair involves a lot of judgment. It seems to be fair in an emergency, but may be unfair at other times, say during rush hour.

Furthermore, it also depends on if you benefit. If you’re an Uber driver (or Uber, itself), you probably view surge pricing in an entirely different way than an Uber rider does.

The point is that surge pricing isn’t inherently fair or unfair. It all depends on where you stand.