The Economics of Uber
Uber, the mobile application that allows passengers to hail Uber cars to their location, has broken into a market that has long been dominated by monopolistic taxi providers. In the context of cities especially, the taxi industry has become entrenched in oligopolies – with one or two major taxi companies providing medallions to willing drivers in cities like New York and Boston. This oligopoly, characterized by the high barriers to entry – i.e. the $500,000 driver medallion needed to be employed by the taxi service, represents a very real example of game theoretic competition alongside the entrance of Uber.
Uber’s disruption to the industry, gouging a large portion of the taxi service’s market share, came with lower prices, travel time minimization, and convenience. The price of riding a taxi prior to Uber represented a cost far above perfect competition. In a series of price undercuts among the taxi services and Uber (with the lower price provider stealing much of the market share), the cost of riding a car has come closer to the marginal cost of providing the service.
This method of price cutting to take hold of a market can be modeled in game theory in the context of monopolistic competition. Starting with the initial “monopoly”, the taxi service, which controlled the entire market, Uber had two options – take the entire market through offering a lower price, or collaborate with the taxi services to arrive at a single price that both parties will commit to offeing and split the market share. Furthermore, even after prices have stabilized, both Uber and the taxi services face the decision everyday of whether to stick with the current price offered by both companies (collaborate) or undercut the others’ price and take the entire market share for a temporary period (cut). I have recreated this game theoretic model using the following assumptions:
In this model, it is demonstrated that the price cutter will “win” only if the other party chooses to collaborate (in which case they take the entire market). However, if the other party also chooses to cut, both parties are intrinsically worse off than if they had both collaborated (as the maintain the same market share (but at a lower price). Thus, the decision is based on what each company believes the other party will do. Pure game theorists may state that it is in the best interest of both companies to continue cutting price to the marginal cost of the service – reaching a state of no economic profit. This concept of continuous undercutting in game theory is called a Bertrand game. In reality, prices may steady at some premium over time.
This same game theoretic model can also be applied to other monopolistic companies providing similar services including Uber and Lyft, or Hail-O and TaxiMagic. It can also be applied to analyze where Uber should set surge pricing.
In this way, game theoretic concepts can be linked to many real applications including the Uber/Taxi industry oligopoly and a myriad of other situations.
Links:
http://economicstudents.com/2014/08/the-economics-of-uber/