Sunday 9 June 2019

Uber is a tax on ride-sharing

This post follows up on yesterday's post about Uber, where we established that most of the benefit of Uber accrues to passengers, rather than to drivers. This is because of the shape of the demand and supply curves (steep demand, and flat supply). The New York Times article has more of interest though:
Economics says that the likelihood that a person will bear the burden of an increase in profit margins is inversely proportional to their price sensitivity. In other words, because drivers are four times more price sensitive than riders, a reasonable guess is that 80 percent of the price burden will fall on passengers, 20 percent on drivers.
The simple demand-and-supply diagram that I drew yesterday isn't the full story of the market for ride-sharing. It only showed the economic welfare of passengers (consumer surplus) and drivers (producer surplus). However, there is an important third party acting in this market: Uber.

Uber acts as a tax on the market for ride-sharing, because it essentially takes a cut of the value of every ride. This is essentially the same as the government taking a share of every sale (as in a sales tax), except that the money is going to Uber, rather than to the government. Who pays Uber? You might think it is the drivers - after all, the fee to Uber is taken out of what the consumer pays, before the net amount is given to drivers. But it turns out that actually, the 'Uber tax' is shared between passengers and drivers, and it is the passengers who pay the larger share.

To see why, let's modify the diagram from yesterday's post. This is shown below. If Uber charged a zero percent fee, then the market would operate at equilibrium, and the price would be PE and the quantity of rides would be QE (this is the situation we had yesterday). However, now let's introduce Uber's fees. Since it is the drivers who pay the fees to Uber (it is taken out of their pay), it is like an increase in their costs. It isn't really an increase in their costs, so the supply curve (which is also the marginal cost curve) doesn't shift. Instead, we represent this with a new curve, S+tax. The vertical distance between the supply curve (S) and the S+tax curve is the per-ride value of the tax. [*] The price that consumers pay will increase to PC, where the S+tax curve intersects the demand curve. From that price, the fee to Uber is deducted, which leaves the drivers with the lower price PP. Notice that the passengers' price has gone up by a lot, while the drivers' effective price has dropped by only a little. This tells you that the passengers are paying most of the Uber tax. The quantity of Uber rides falls from QE to QT.


We can also look at this using economic welfare. Without the Uber tax, the market operates in equilibrium. The consumer surplus (as we established yesterday) is the triangle AEPE, while the producer surplus is the triangle PEEC. However, this changes when the Uber tax is introduced. Now the consumer surplus (the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price)) is the smaller triangle ABPC. The passengers have lost the area PCBEPE. The producer surplus (the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve)) is the smaller triangle PPFC. The drivers have lost the area PEEFPP.

The total amount of welfare that Uber gains is the rectangle PCBFPP (this rectangle is the per-unit value of the Uber tax, multiplied by the quantity of rides QT). This is the size of the Uber tax. We can split the Uber tax into the share paid by passengers (PCBGPE), based on the higher price they receive, and the share paid by drivers (PEGFPP), based on the lower effective price they receive. Note that the share of the Uber tax paid by passengers is much larger than the share paid by drivers.

The New York Times article notes that:
Uber and Lyft, the two leading ride-share companies, have lost a great deal of money and don’t project a profit any time soon.
Yet they are both trading on public markets with a combined worth of more than $80 billion. Investors presumably expect that these companies will some day find a path to profitability, which leaves us with a fundamental question: Will that extra money come mainly from higher prices paid by consumers or from lower wages paid to drivers?
Old-fashioned economics provides an answer: Passengers, not drivers, are likely to be the main source of financial improvement...
And now, hopefully, you can see why. If Uber raises the share of the price paid by consumers that it keeps, then it is passengers that will pay the majority of that higher Uber tax. [**] Which seems fair, since yesterday we established that it is passengers who benefit the most from Uber.

*****

[*] Strictly speaking, the 'Uber tax' is an ad valorem tax. That means that it is a percentage of the price paid by the passengers. That means that the distance between the supply curve and the S+tax curve should get larger when the price is higher. However, for simplicity, I've represented the Uber tax as a specific tax. A specific tax is a constant per-unit dollar amount, which means that the supply curve and the S+tax curve are parallel. It's a simplification, but inconsequential for our purposes here.

[**] If you increase the size of the Uber tax, then the distance between the supply curve and the S+tax curve increases. This further reduces the consumer surplus and producer surplus. The additional revenue for Uber will be predominantly paid by passengers in the form of a higher price. We could show this with an additional diagram that has a small tax, and then a large tax. But, a diagram with a small tax replaced by a large tax is not that different in its effects from a diagram with a zero tax replaced by a small tax. I decided not to go that far. Call me lazy if you want.

[HT: The Dangerous Economist]

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