Passengers benefit more from Uber than drivers

When a seller sells a good or service to a buyer, a surplus (economic welfare) is created. The buyer receives something they wanted to buy, usually for a price that is less than the maximum they were willing to pay for it. The seller offloads something they wanted to sell, usually for a price that is more than the minimum they were willing to receive for it (their costs). So, both the buyer and the seller benefit. Who benefits the most though?

The Dangerous Economist points to this New York Times article about Uber:

The most comprehensive study of rider behavior in the marketplace found that riders didn’t change their behavior much when prices surged. (Like most major quantitative studies about Uber, it relied on the company’s data and included the participation of an Uber employee.)

Passengers were what economists call “inelastic,” meaning demand for rides fell by less than prices rose. For every 10 percent increase in price, demand fell by only about 5 percent.

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.”

In other words, while demand is price inelastic (passengers are relatively insensitive to price changes), supply is price elastic (drivers are very sensitive to price changes). Interestingly, in the case of demand this is the opposite of what I concluded in this 2015 post. [*]

These elasticities are reflected in the diagram below. The demand curve is steep, which reflects that passengers are not very sensitive to prices - a small change in price will lead to almost no change in the quantity demanded. The supply curve, on the other hand, is flat, which reflects that drivers are very sensitive to prices - a small change in price will lead to a large change in the number of rides on offer.

However, that doesn't yet answer the question as to which side of the market (passengers or drivers) benefits the most from Uber. We need to consider their shares of the total welfare created. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity, consumer surplus is the triangle AEPE. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, consumer surplus is the triangle PEEC.

Notice that, because of the shape of the demand and supply curves, the size of the consumer surplus (AEPE) is much larger than the size of the producer surplus (PEEC). Passengers (as a group) benefit much more than drivers (as a group). Note that this isn't quite the same thing as saying that each passenger benefits more than each driver, because the consumer surplus is split among many more people than the producer surplus. However, it is clear that passengers benefit more from Uber than drivers do.

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[*] However, it could be that in 2015, demand was elastic, while demand has become less elastic over time and is now inelastic. It's hard to see why that would be the case. The rise of other substitutes would tend to suggest increasing elasticity for Uber rides. Or, perhaps demand is more elastic in New Zealand (which my 2015 post was based on) than in the U.S. (which this article is based on)? Again, it's hard to see why that would be the case, unless Uber prices in New Zealand in 2015 were much higher than in the U.S. now.

Read more:

• Uber just told us there is elastic demand for rides