This article talks about the government of Maharashtra’s decision to place a price ceiling (upper limit on price) on fares of app-based taxis, intending to bring down cost of commute for consumers.
The app-based taxi market in India is duopolistic in nature, meaning the market is dominated by two firms: Indian company Ola and US-based multinational Uber. The business models of Ola and Uber are similar. Under this model, each driver has complete freedom in deciding when and for how long their car runs as a taxi. The prices they charge are fixed by the firm and are affordable, but during periods of high demand, the companies temporarily hike their prices in a policy known as surge pricing, which is what the price ceiling intends to stop.
Refer to diagram A. Before the imposition of the price ceiling, the market was operating at equilibrium point E, with quantity traded Q1 and price P1. The consumer surplus (The difference between the consumers’ valuation of the rides and how much they paid for them) is shaded in red. It is the total vertical area between the demand curve D and the price line. It represents the benefit the customers received by consuming the product. The producer surplus (The difference between the producers’ valuation of the rides and how much they received for them) is shaded in yellow. It is the total vertical area between the supply curve S and the price line. It represents the benefit the producers received by supplying the product. Diagram B depicts the market after the imposition of a price ceiling at price Pc. At this price, suppliers are only willing to supply Q2 rides while the consumers demand Q3 rides, creating an excess demand of Q3Q2. The change in consumer surplus is uncertain. There is a clear loss of producer surplus of area P1EWPc. Social surplus- the sum of consumer and producer surplus and is representative of the total benefit to society of production of a good- also falls. This loss in social surplus is called dead weight loss (shaded blue). It represents possible benefit to society that is being wasted.
The price ceiling placed by the government impacts many different stakeholders. The effect on the suppliers- the drivers, and indirectly Ola and Uber- is only negative. The government is forcing suppliers to produce fewer rides than the market value, and sell them at a lower price than market. This causes a fall in revenue.
At first glance, consumers seem to benefit due to this price ceiling. After all, they have to pay a lower fare for their rides. However there is excess demand, implying that some consumers who were willing and able to get the ride at this price are unable to do so due to shortages and certainly these consumers have not benefitted from the price ceiling. Even those who were able to get a ride at the lower fare have to face some significant difficulties. Taxis are assigned on a ‘first come, first serve basis’ but due to the shortage of taxis, this will result in very long waiting times for consumers. Thus consumers only stand to benefit if the government’s unlikely assumption that people prefer wasting time to spending some money holds true.
A shadow market of sorts may also develop wherein the drivers demand that the customers pay them more than the printed fare if they want to take the ride otherwise they will cancel, forcing the customers to wait again. This is obviously disadvantageous to consumers, but also to the government as these types of transactions manage to evade taxes.
The reduced spending on the taxis also reduces the amount of indirect tax (tax on expenditure) the government receives, while the lower earnings of the firms and the drivers reduces the amount of corporation and income tax the government receives. Thus this move is disadvantageous for the government.
The society also loses out as a result of his decision, as it causes allocative inefficiency. However there are also some benefits to society due to this price ceiling. Taxis have negative externalities (costs imposed on a third party for which they receive no compensation) like traffic and air pollution. Unavailability of taxis may encourage consumers to switch to substitutes which reduce these externalities, like bicycles or metros, which would be a positive outcome.
However, I believe that the cons of this decision clearly outweigh the pros and the government should look for a different solution to the high cost of taxi rides