Is Dynamic Pricing Unfair?

I wrote a chapter on dynamic or demand-based pricing for a new book "The War on Prices: How Popular Misconceptions about Prices Create Bad Policy"

This week Ryan Bourne released a new book, “The War on Prices: How Popular Misconceptions about Inflation, Prices, and Value Create Bad Policy.” It debunks common misunderstandings about inflation, highlights the harmful consequences of current and historical government price controls, and addresses some misguided moral and economic arguments that drive these counterproductive policies. Discourse Magazine published a thorough review of the book, and Ryan discusses it on his Substack here.

In this post, I’ll highlight my chapter in the book on dynamic pricing.

What is Dynamic Pricing?

Many of us are accustomed to “surge pricing” when requesting Ubers during rush hour or booking last-minute flights over Christmas. But these types of dynamic pricing strategies are now creeping into daily life—just a few months ago, for example, Wendy’s faced a social media backlash when it announced plans to increase menu prices during its busiest hours.

Sometimes referred to as “algorithmic,” or “demand-based,” or “surge” pricing, “dynamic pricing” is a practice in which the price of a good or service fluctuates in real time based on market supply and, especially, demand. That makes it different from fixed or static pricing, where the price remains relatively constant over some period: for example, the apple at your local grocery store will likely stay at around the same price from week to week, irrespective of how busy the supermarket is.

Dynamic pricing is why you can get a cheap flight to Italy if you book in advance for the “low demand” colder months but will pay a high price for a last-minute trip in July during the “high demand” school holidays.

Now that more transportation, hospitality, and e-commerce platforms use dynamic pricing in industries where customers have traditionally seen more price stability, concerns about fairness are on the rise.

The Economics of Dynamic Pricing

Most business don’t price dynamically. At your grocery store, you will often see consistent, static pricing of goods throughout the day, without shelves ever becoming barren. Grocery stores opt to use inventory to manage fluctuations in demand, and customers pay slightly higher prices for each item—a premium—to have the goods available to them at a consistent price throughout the day.

Businesses usually consider it more profitable, on balance, to avoid surprising consumers, or to invest in systems that keep supply more elastic to predictable demand shifts.

Yet there are costs to this uniform pricing approach. In grocery stores, there’s extensive food waste due to consumers’ reluctance to buy expiring produce, empty shelves during very high-demand times like just before hurricanes, and long check out times during rush-hour grocery shopping.

In general, dynamic pricing strategies tend to be most valuable in two types of markets: (1) Where there is a short-term flexible supply that can move to meet demand, like in ridesharing; or (2) Where there is fixed or limited capacity that needs to be efficiently allocated in a market with uncertain demand, like in hotels or the airline industry.

In the first market type of market, economists generally agree that the main benefit of dynamic pricing strategies is that it can help balance supply to meet customer demand. No case is clearer than that of ridesharing, where dynamic pricing strategies and a flexible labor supply are at the core of the business.

For example, when there is a mass transit malfunction in your area, the price of your Uber will undoubtedly increase. Beyond irritating customers, this algorithm-generated high price serves two important purposes: First, some customers who merely had a slight preference for the Uber may reconsider it and decide to walk instead, cancel evening plans or stay longer in the office until the price falls again.

The second effect of the higher price is that it serves as a signal to Uber drivers to get out on the road. There are people who need the ride, and they are willing to pay handsomely. Drivers see that they can make good money servicing a particular area at a particular time, and this encourages them to supply rides where they are needed.

In other words, surge pricing is a way of asking customers: “Do you really need to take this ride right now?” This rationing by price helps to minimize the number of riders using the service frivolously during the high-demand time. And it helps to ensure that those who need or value the rideshare most take that ride.

Indeed, in one study, economists found that drivers extended their sessions and provided significantly more rides when they saw surge pricing in a particular geographic area. Another study’s comparison to New York City taxicabs, where there is no dynamic pricing (only slight peak-hours fare increases twice a day), showed that the number of Uber and Lyft rides rose by 22 percent during rainy hours compared to just 5 percent for ordinary taxis.

The ridesharing company Gett’s experimentation with fixed prices – which earned it the title of “Uber without Surge Pricing” – quickly failed in New York City and demonstrated what happens without dynamic pricing in a market where customers demand immediate service. I remember that I had to wait longer than 45 minutes (!) to find a ride at peak hours or on rainy days because not enough drivers were available.

In the remainder of the chapter…

When supply cannot move like in the case of Uber, how does dynamic pricing work? Who benefits from dynamic pricing in those cases? Is it fair that customers are charged exorbitant prices for hotel rooms and Taylor Swift concerts? And if dynamic pricing hits the grocery store, what about the legitimate concern that goods will become unaffordable at popular times for low-income and financially strained individuals?

What does the empirical evidence say about who benefits with ‘surge’ pricing in ridesharing, or dynamic pricing in the airline industry? Consumers, companies, or both? What do we know about the long-run effects (on prices, supply, etc.) in industries that use dynamic pricing strategies?

I cover these questions and also address concerns of fairness, especially when prices skyrocket during emergency situations, e.g. the “price gouging” problem.

One last thing I’ll point out though is that people tend to forget that fluctuating prices mean that prices move both up and down. Dynamic pricing allows consumers to access a good or service that is below a normal fare when demand is low. Airline tickets have become affordable for many millions of Americans who take advantage of low prices by booking far in advance and during off-peak hours.

I hope you’ll consider reading the book

In addition to my chapter on dynamic pricing, the book has chapters on inflation, the labor theory of value, whether prices corrupt, the gender pay gap, pink tax, CEO pay, and in-depth analyses of price controls on rents, financial services, healthcare, wages, water, oil & gas, food, & more.

Finally, each chapter aims to provide the most charitable interpretation of the ‘other side’ of the argument. Dan Rothschild nicely sums up this element of the book:

This charity is a hallmark of the entire volume, and it is a great credit both to Bourne as editor and the contributors he recruited that they avoid the temptation to mock and belittle arguments they oppose—as easy in some cases as it would be. Rather, they steelman and address the best possible versions of the arguments they reject. Such intellectual honesty has fallen out of fashion in many circles, and Bourne et al. equip themselves well in bucking the temptation to simply label and dismiss opponents. Such an approach would likely sell more books, but readers would be the poorer for it.

The book is available for purchase on Amazon.