Uber has received significant media coverage in the past few days as recent storms drew attention to their surge pricing model. Heated discussions around the merits and morality of the strategy are crowding the web; in terms of economic theory, the model makes perfect sense — but it makes people furious.

"We did more trips because of our approach, not fewer. We gave people more options to get around, and that is the whole frickin’ goal." - Travis Kalanick

Uber charges more when the demand for their services increases. For example, during rush hour, Uber's algorithm increases prices to increase the supply of drivers, maximizing the number of rides completed (as well as Uber's profit).

This makes sense, but becomes a disputed business practice when natural events (e.g., snowstorms) are the cause for the increased demand. Prices have been known to go up by more than 7 times the original fare under extreme scenarios. Kalanick says that increasing prices ensures that anyone who wants a ride and can pay for one will get one, thus satisfying Uber’s core value of reliability (a full response from Kalanick to a customer outraged with the fees can be found on his public Facebook page). Basic economics are on Kalanick's side - when demand increases, prices need to increase to encourage an increase in supply, until the market clears (and in a free market, this would also maximize Uber’s profit). Technically, the flexible pricing mechanism means greater market efficiency.

However, economic theory also points to the Big Tradeoff: there is a trade-off between efficiency and equality. And this is the core of the problem: Uber’s pricing model targets efficiency over equality, and the surge fees price certain types of people out of the market. Tied with the fact that demand for taxi services correlatives positively to extreme weather changes, some see it as an example of price gouging, which is illegal in most states in the US.

This is where black and white turn to grey. One of the biggest points in favour of labeling Uber’s pricing model as a gouging strategy is the lack of a price-finding mechanism. In a real open market, the demand has the opportunity to bid upon the good or service, but this mechanism is replaced by a proprietary algorithm on Uber’s platform. The calculation is a black box, so we have no idea what’s really going on and for all we know, it might not be efficient. On the flip side, in order for price gouging to truly exist, there needs to be a monopolistic player (or consumers would switch to a competing product rather than pay the outrageous fees). A variety of other options are out there, and Uber doesn’t control the prices set by these alternatives. Even in times of extreme weather, it’s unlikely that Uber is the only option available.

Ultimately, Uber is a private organization. They have no legal or moral responsibility to cater to those who can’t afford the prices they set. Whether the model and the underlying attitude hold up, and whether Uber survives in the long run despite the negative publicity, controversial model, regulatory issues, and inevitable backlash from traditional cab companies - should be an interesting story to watch as it evolves. On average, Uber has been cheaper, more convenient, and a more pleasant experience for me. The "business model" for drivers is yet to be proven, but most stakeholders in the ecosystem win (except for traditional cab companies).

If I could decide Uber's response to this backlash, I'd focus on increasing the transparency surrounding the pricing mechanism through in-app messaging and analysis. I'd also only take the Uber commission (~25%) off the base price, not the surge price. This would have several benefits:

• Uber would not be seen as profiting off periods of high demand such as natural disasters and other emergencies; in conjunction with increased transparency, I think this would be enough to sway customers' opinions in Uber's favour.
• The average price would be lower - e.g., a $10 ride at 5x surge today would be $50 and Uber's commission would be $12.5. Taking a fee only on the base would reduce this to $2.5, and thus the ride would only need to cost $40 while still paying the driver the amount they needed to go on the road and add to the supply.
• This would still maximize Uber's profit on the supply / demand curve, as they're still maximizing the matching between riders and drivers. It would be less than it is today, but without the cost of the negative press, damage control response, etc.

Overall, I think variable demand-based pricing is a great idea and one that we should see more often, as long as the right checks and balances are in place to comfort users.

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