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Ignore the demagoguery

Truth is, pricing fiats by the state are counter-productive and ineffective.

Written by Sudhir A. Shah , Payal Malik | Updated: May 7, 2016 6:44:42 am

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The controversy surrounding App-based cabs and their pricing has been characterised by much demagoguery. We seek to leaven the debate with straightforward economic rationality. Given exogenous factors such as the weather and the time of day, the instantaneous demand and supply of taxis vary with the price, the former negatively and the latter positively. At a given price, they vary with the exogenous factors. Given the exogenous factors, a price that equates demand and supply is called an equilibrium price. This price leaves no potential gains-from-trade on the table: Everyone who wants to buy or sell the service at that price can do so. A higher (respectively lower) than equilibrium price is inefficient because some cabbies and some customers can negotiate a mutually beneficial trade at a lower (respectively higher) price.

The state fixes two parts of the taxi market. First, it limits supply by mandating a permit for operating a taxi, thereby making the supply of taxis very inelastic. Second, it fixes the price of the service. Unfortunately, this price is rarely the equilibrium price because changing exogenous factors move demand and supply, leading to a fluctuating equilibrium price. For instance, during peak commuting hours or severe weather conditions, demand usually exceeds supply at the mandated price. At off-peak times, the opposite is true. Both situations are inefficient as mutually beneficial trades remain unrealised.

Hitherto, such trade has been difficult for two reasons. First, the potential traders have to find each other and until now there has not been a platform for making such matches at low cost in real time. Second, even if the potential traders randomly bump into each other, haggling imposes a significant cost in terms of time and psychological distress. App-based cab services solve both problems. The software matches, in real time and at low cost, customers and cabbies who are willing to trade at the specified price. As both parties accept the price, haggling is irrelevant. By replacing random physical matching and haggling with a virtual platform for precise real-time matching of traders and auction-based pricing, App-based cabs implement the mutually beneficial trades implied by demand-supply mismatches. While prices increase (as they should) when demand is greater than supply, they also fall (as they should) when supply is greater than demand.

App-based cabs bring other benefits too. First, the taxi market becomes more competitive as there is a larger number of suppliers across the quality spectrum. The days of the neighbourhood taxi-stand being a local monopoly, with all that a monopoly entails, are over. Hence, the protests from such quarters. Other than legal and administrative barriers, entry into the taxi market is easy because the required software is easily acquired and the entrant does not have to invest in a car fleet, since one only needs to incentivise car owners to acquire an appropriate license and become part or full-time cabbies.

Second, the ability of the supply-side of the market to respond flexibly to price signals makes the taxi supply far more elastic than under a rigid permit regime. Third, there is a marked improvement in the quality of service relative to the neighbourhood taxi-stand benchmark. This should enable a switch away from private cars to public taxis, leading to lower congestion and pollution. Fourth, off-peak prices are much lower than those of traditional cabs.

Indeed, they rival auto-rickshaw prices, hence their protests. Peak-time prices are higher than the mandated price. However, the mandated price is irrelevant at peak-times since every cabbie can and does charge a premium at such times. Ask any commuter. The notion that your cabbie is an economic idiot who abides by the mandated price, whatever be the true economic value of his service, is a shibboleth that should be buried next to other statist nonsense.

What is the proper role of the state in this market? It is certainly not to ban flex-price cabs or regulate prices since this market is very competitive. If we learn anything from economic history, it is that trade at market-determined prices is a remarkably resilient institution with far greater embedded intelligence and creativity than any state authority. Not only are bans and pricing fiats generally counter-productive, they are also ineffective if the targets of such coercive actions have the means and motives to subvert the state’s directives. So, the state should concentrate on its legitimate functions of implementing quality-of-service standards, and more generally, enforcing traffic laws.


Economic rationality, of course, does not prevent ill-advised market interventions by rent-seeking politicians and supposedly do-gooding, but ultimately pernicious and perfidious, pressure groups with an ideological or business axe to grind. Economic history is replete with examples of the former, while the manufactured hysteria around GM crops and net-neutrality are examples of the latter. One can only hope that better sense prevails in the case of the humble taxis.



Sudhir is a professor of Economics, Delhi School of Economics. Payal is an associate professor at PGDAV College, University of Delhi and formerly advisor economics,Competition Commission of India.

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