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Paul Krugman's Excellent Point About Uber's Surge Pricing

Dec 22 2013, 9:11am CST | by

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Paul Krugman's Excellent Point About Uber's Surge Pricing

Paul Krugman is using Uber’s surge pricing as an example, as something to bolster a core part of the Keynesian economic model. But that’s fine for he’s doing it really rather well. The basic point is that we all rather like the effects of market forces and price changes on the economy in general we get rather less happy about it when they affect us and a more personal  relationship :

Which brings me to Uber, the smartphone-based car service. Uber, it turns out, doesn’t charge fixed prices; it practices surge pricing, in which prices depend on the state of demand. So when there’s a snowstorm or something that makes everyone want a car at the same time, prices go way up — sometimes sevenfold.

This makes a lot of sense from a rational economic point of view — and it makes people totally furious. It turns out that people are OK with fluctuating prices when it’s really an impersonal market — but they get really angry at any hint that someone with whom they have some sort of ongoing relationship is exploiting their distress.

Surge pricing is, from the other side of the fence, often called price gouging. When there’s a disaster, should suppliers raise prices on things that are in limited supply? In terms of short term economic efficiency yes, they most certainly should. In the long term perhaps not so much as the reaction (to say nothing about the laws in many places that prevent it) to it from formerly loyal customers can be vitriolic. In fact, we find that companies like WalMart, who arguably should vary prices at such times, determinedly do not. They instead load up and run as many trucks of supplies into those affected areas as they can. You could call this making money on volume instead of margins but the real reason they do it is precisely because they know that raising prices would lead them to having a long term fall in business.

Another way of putting this is that economic efficiency is all very well but we humans don’t particularly like economic efficiency when applied to ourselves.

Krugman goes on to point out that this becomes a basic of a part of Keynesian economics:

What does this have to do with the macro wars? Well, back in the 1990s the economist Truman Bewley — an economist heretofore known for high theory in microeconomics — did something novel on the subject of wages, and why they don’t fall in recessions: he went out and asked people. And what he found was that issues of fairness and morale were key. Employers didn’t cut wages, even when unemployment was high and they knew that employees had no place to go, because they believed that morale and workplace cooperation would collapse if their employees felt that the company was exploiting a bad economy for its own gain.

Or as the models themselves assume, wages are sticky downwards. Now we could in fact say that employers here were mistaken: but that would violate two further points. The first being Hayek’s, that information is local. Employers are a better guide to what will happen than non-employers here, for they are the people with local knowledge. And we’ve also got a certain amount of historical knowledge to work with too. In between around 1850 and 1935 there were a number of occasions where wages were indeed cut both in the US and the UK. There were also a number of occasions when large numbers of people were fired: both of course had the same cause, that particular business or trade wasn’t doing well at that time. And firing people caused a lot less resentment (up to and including riots in fact) than cutting everyone’s wages did.

So we could in fact say that employers have tried being economically efficient on this matter and found out that, given human preferences, it didn’t really work all that well.

We’ve also found out in this recession, at least in the UK, that people aren’t so worried about falling real wages. Inflation has been above pay rises for several years now leading to a perhaps 8% decline in real wages. That’s one of the reasons that unemployment hasn’t soared. But while real wages have fallen without much fuss I hate to imagine the furore we would have had if nominal wages had been cut by 8%. I personally, on the basis of this evidence, would therefore agree that one contention of Keynes’ has been proven to be true. That nominal wages are sticky downwards. For no other reason than that humans are indeed humans.

Source: Forbes


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