Supply and Demand in the Context of Uber Surge Pricing

This question assumes a basic understanding of market operations. Thus, it may be used early in a principles of microeconomics course after covering supply and demand shifts and equilibrium. The question is structured to bring attention to the often confused difference between changes in quantity demanded as a result of a price change and changes in demand that prompt a price change. Specifically, students are asked to determine whether it is better to drive during busy times and in busy locations when and where surge pricing is in operation or instead to avoid these locations and times because the high price leads to decreased demand. I find that reviewing (or at least reminding students of) the difference between demand shifts and changes in quantity demanded prior to beginning the exercise is helpful. Note that if already covered in class, the concept of price elasticity of supply also can be incorporated into the question to distinguish scenarios in which increased competition (and excess quantity supplied) from the higher price decreases the probability of securing a fare to such an extent that total revenue expectations are decreased. However, this is completely optional.

The application context requires little introduction as most students are familiar with ride sharing services. I sometimes start with a simple show of hands as to who has ever used Uber or Lyft. Then, if there are a number of students who do not raise their hands, I ask students familiar with the service to explain it to those who are not and/or I have students google the app and familiarize themselves with it. The only aspect of the question context that may require some explanation is the surge pricing idea. However, as students have recently covered shifting demand leading to equilibrium price increases, I generally spend little time in explanation beyond what is in the prefatory remarks and the brief article, below.

Assuming that the review of changes in Qd vs shifts in demand takes only a short period of time, this activity can be completed within a 55 minute class period or as part of a longer 80 minute class period. This activity is appropriate for both large and small class sizes because the open ended nature of the question and options ensures debate.

Overview

This activity has students apply the basic supply and demand principles behind surge pricing used by Uber to help them determine an optimal revenue maximizing strategy if they were to become Uber drivers. The question is structured to bring attention to the often confused difference between changes in quantity demanded as a result of a price change and changes in demand that prompt a price change. Specifically, students are asked to determine whether it is better to drive during busy times and in busy locations when and where surge pricing is in operation or instead to avoid these locations and times because the high price leads to decreased demand. Thus, the question contains a "red herring" option likely to be incorrectly selected by a number of students. Discussion of this option within the groups and then in the larger class should reinforce the error in reasoning associated with the false option.

This question assumes a basic understanding of demand shifts and market adjustment to a new equilibrium. Thus, it is appropriate for use quite early in a principles of microeconomics course. Concepts of elasticity can be brought in, if that material has been covered. However, this is not required. Further, given that most students are familiar with Uber as passengers, and an increasing number of them also have experience as Uber drivers, the question has direct relevance to their lived experience and does not require additional materials (although material on surge pricing are provided to be used as needed).

Expected Student Learning Outcomes

Students will be able to use supply and demand modelling to predict equilibrium price and quantity changes as a result of a market shock.

Students will be able to distinguish between a change in demand that leads to a price change and a change in quantity demanded or quantity supplied that results from that price change.

Information Given to Students

Uber drivers are paid based upon the time and distance of a given trip and the Uber fare rate in operation at the time that they are with a passenger. The Uber fare rate is determined through a system known as "surge pricing" that charges a higher rate during times when many passengers are seeking service.

Which of the following is the best strategy to follow as an Uber driver if you wish to maximize your total compensation per hour of driving? Be prepared to use the supply and demand for Uber rides to support your answer.

A. Uber fares (and thus driver pay) are higher during busy times such as after a concert or sporting event lets out. Therefore, it is better to locate near event venues and drive during busy times when fares are high.

B. The higher Uber fares charged during busy times such as after a concert or sporting event lets out decrease rider demand. Therefore, it is better to avoid large event venues and drive when fares are lower.

C. The high Uber fares during busy times increase the number of Uber drivers in the area making it more difficult for the drivers to find passengers. Therefore, it is better to avoid large event venues and drive elsewhere.

Note: team reporters should be prepared with notes that show the appropriate supply-demand analysis to support the team answer.

Prefatory Remarks

Ride sharing services such as Uber and Lyft are becoming increasingly popular as a means of transportation in both urban and more suburban/rural settings. An interesting feature of the Uber model is that Uber drivers are paid based upon the time and distance of a given trip and the Uber fare rate in operation at the time that they are with a passenger. The Uber fare rate is determined through a system known as "surge pricing" that charges a higher rate during times when many passengers are seeking service.

Debriefing notes, including discussion questions:

After the reveal, ask various team reporters to explain their reasoning. After the verbal explanations, the instructor should ask reporters to bring their S-D diagramatic analysis of the situation to the doc cam, if one is available.

While this question has a single correct answer (A), it is likely to engender conversation because it embeds a common student misperception (one might say a trap). Specifically, by enabling students to incorrectly model a decrease in quantity demanded from a demand induced higher surge price as a demand decrease, it prompts them to explore the intuitive dissonance of answer (B). Because student confusion between changes in supply and demand and changes in quantities supplied and demanded is so pervasive, giving students an opportunity to debate it openly is likely to assist in building stronger and more accurate intuition around supply and demand modeling more generally.

Choice C might also attract some teams. In the context of the competitive model, C makes little sense. We have assumed away differences in driver ratings and other quality ratings. To the extent that strategic interaction among drivers is important, we would need to model that differently -- perhaps with a Hotelling location model. This is a good time to remind students that the S-D model rests on some very strong assumptions, which will be explored more carefully in subsequent modules that consider those assumptions carefully and then consider situations where the assumptions don't hold -- namely, the cases of imperfect competition and the presence of externalities.

This question has left firm costs out of consideration, but, of course they are important for decision-making about whether to locate near busy events. Instructors might explore this aspect of the question with students in the late stages of the debriefing by asking questions like, "would you expect it to be harder to find Uber drivers in other parts of the city during busy times?" This would open up an interesting set of issues that could reveal insights that include (1) Uber drivers with lower opportunity costs would be the most likely to move to busy locations (in the S-D graph, there are Uber drivers that are not attracted to the area -- the supply curve above the market-clearing price) and (2) some occasional Uber drivers would pick busy times as the best hours to work (the instructor can preview the elasticity of supply topic at this point).

Closing remarks:
The rising demand that leads to higher Uber "surge prices" in some locations and at some times may discourage certain customers from using the ride sharing service, but this is a change in quantity demanded due to this higher price, represented as a shift along the demand line, rather than a shift in demand. In fact, demand NEVER shifts as a result of own price change.

Overall, the basic supply and demand model provides important insight into rising/falling prices and increases/decreases in business across many markets that affect us as daily consumers and producers.

In the final 10 minutes of class the instructor could have students conduct a guided reflection on this activity by having them perform the following tasks in their notes or in a sort of one-minute paper.

First, determine which of the question options (A-C) you would select, given what you have learned. This need not be the same as your group choice or what you would have selected before the classroom discussion.
Then, write one sentence justifying this choice ("I believe _______ is the best Uber driver strategy because...").
Finally, provide a one sentence statement that summarizes what you feel that you learned through the group exercise and class debate.

Students are asked, at the end of this activity, to identify their own answer to the activity prompt. This need not be what they originally thought or what their team decided. Then they are asked to justify why they made the choice that they did. Finally, they are asked to provide a one sentence statement that summarizes what they learned through the group exercise and class debate. This material is collected from a sample of students and assessed against a rubric [TBD] to determine if the learning outcome has been met.

Yes, Uber Expects New Year's Eve Surge Pricing. Here's What to Expect (Sarah Gray in Fortune 12/27/17): This article explains how surge pricing operates. It is a good background article that details the practice as perceived by customers.
http://fortune.com/2017/12/29/uber-surge-pricing-new-years-eve/