Monday, 10 June 2019

Why Uber drivers will make no money in the long run

This is the third post in as many days about Uber (see here and here for the earlier installments), all based on this New York Times article. Today, I'm going to focus on this bit of the article:

Drivers, on the other hand, are quite sensitive to prices — that is, their wages — largely because there are so many people who are ready to start driving at any time. If prices change, people enter or exit the market, pushing the average wage to what is known as the “market rate.”
The article is partially right here. It isn't just the price elasticity of supply that is at fault - it is the lack of barriers to entry into (and exit from) the market that create a real problem for drivers. A 'barrier to entry' is something that makes it difficult for other potential suppliers to get into the market. A taxi medallion is one example, if a medallion is required before you can drive a taxi. However, there is nothing special required in order to be an Uber driver, and most people could do it. Similarly, a 'barrier to exit' is something that makes it difficult for suppliers to get out of the market once they are in it, such as a long-term contract. Barriers to exit can create a barrier to entry, because potential suppliers might not want to get into a market in the first place, if it is difficult to get out of later if things go wrong. Again, Uber has no barriers to exit for drivers. These low barriers (to entry and exit) ensure that, in the long run, drivers can't make any more money from driving than they could from their next best alternative.

To see why, consider the diagrams below. The diagram on the left represents the market for Uber rides. For simplicity, I've ignored the 'Uber tax' (that I discussed in yesterday's post). The diagram on the right tracks the profits of Uber drivers over time. The market starts in equilibrium, where demand is D0, supply is S0, and the price of an Uber ride is P0. This is associated with a level of profits for Uber drivers of π0. For reasons we will get to, this is the same earnings that an Uber driver would get in their next best alternative (maybe that's driving for Domino's, or as a taxi driver, or working as a stripper).


Now, say there is a big increase in demand for ride-sharing, from D0 to D1. The price of an Uber ride increases to P1, and the profits for driving increase to π1. Now profits from being an Uber driver are high, but they won't last. That's because many other potential Uber drivers can see these profits, and they enter the market (there are no barriers to entry, remember?). Let's say that lots of drivers enter the market. The supply of Uber drivers increases (from S1 to S2), and as a result the price decreases to P2, and profits for Uber drivers decrease to π2.

Now the profits for Uber drivers are really low. There's no barriers to exit, so some drivers decide they would be better off doing something else (driving for Domino's, etc.). Let's say that a lot of drivers choose to leave, but not all of those who entered the market previously. The supply of Uber drivers decreases (from S2 to S3), and as a result the price increases to P3, and profits for Uber drivers increase to π3.

Now the profits for Uber drivers are high again (but not as high as immediately after the demand increase). Drivers start to enter the market again, and so on, until we end up back at long-run equilibrium, where the price of a ride is back at P0, and driver profits are back at π0. At that point, every driver who is driving makes the same low profit as before. So, in the long run, even if demand for ride-sharing is increasing over time, the drivers are destined not to profit in the long run. [*]

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[*] You might have noticed that the producer surplus is higher after supply increases, which implies that drivers (as a group) are earning higher profits after the market has settled back to long-run equilibrium. However, remember that supply is higher than before - those higher profits are shared among many more drivers, so the profit for each driver individually is the same as before.

[HT: The Dangerous Economist]

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