Imagine a hypothetical San Francisco where Uber/Lyft don\'t have surge prices an
ID: 1203050 • Letter: I
Question
Imagine a hypothetical San Francisco where Uber/Lyft don't have surge prices and also don't tell drivers how much to charge. Thus, taxi fares are set by supply and demand. Typical fares are $2/mile during most times. When it is raining and demand for taxis is high, the price increases to $4 per mile. How does this happen? Remember that there are thousands of taxis, and none of them coordinates with each other. Thus how does the price rise to $4? An ignorant taxi driver tries to maintain the $4/mile price after the rain stops. Why is he unlikely to be able to maintain this price? Do customers benefit when taxis raise their price during the rain? Describe how prices help customers cooperate with each other.Explanation / Answer
(a) When demand for taxi increases, the supply of taxi does not change in short run. Therefore, an excess demand is created leading to shortage of taxis in the market, which raises price level beyond $2. Eventually, the situation arises when, if price is lower than $4, no taxi drivers will work for a fare, and if price is higher than $4, no passengers will ride a taxi. Therefore new equilibrium price becomes $4.
(b) After rain stops, demand for tax falls. In order to operate, taxi drivers will lower their price to get more passengers. So, if the driver keeps charging $4, the pasengers will find out other taxis which will charge lower fare. Facing a loss, the driver has to lower price.
(c) Customers suffer when taxis raise price because they need to pay more to obtain the same service. Consumer surplus decreases, lowering consumer welfare.
The market interaction of demand and supply forces make customers decide on the maximum price they are willing to pay for taxi services, and if the drivers charge a fare above this limit, customers stop using taxi service, thus effectively imposing a price ceiling.