Perspective Unlimited

Monday, January 21, 2008

Deadweight Loss of High Taxi Fare?

The issue of taxi pricing has been a subject of some debate recently. Before the recent changes to the fee structure, the perennial complaint was too few taxis (particularly during peak hours in the city). After the increase in the structured fare, there are many empty taxis around waiting for customers.

Nevertheless, many taxi drivers have reported that though the number of trips they make are down, it is made up for by higher fares, and that overall takings per day have remained roughly the same as before. The question here is whether this situation optimal?

Simple Demand and Supply

We can use a very simple demand and supply structure to answer this question. The caveat here is that some important and complicated factors - such as waiting times, differential demands at different times of the day, effects on congestion, market power - are ignored. The simple demand and supply diagram is presented below.



The market for taxis is subjected to two important forces - the fixed supply of taxis and the controlled price structure. As every economic student can tell, one can either set prices or quantities. It is never possible (in general) to set both prices and quantities and expect demand to be equal to supply (or market clearing).

The demand for taxi is the downward sloping line in the diagram. Suppose the supply of taxis is fixed at Qf. The price before recent changes is at Pl. Total revenue is given by the area O-Pl-F-Ql (simply price Pl times the constrained quantity Qf). At this price however, there is excess demand. Taxi prices are way too low and there aren't enough taxis to go around. This of course explains why you previously could never get a taxi when you needed one.

Recent prices changes have pushed the price to Ph. At this price, the total revenue for taxis becomes the area O-Ph-H-Qh. This area is drawn with the same size as before, which shows that taxi takings have remained unchanged after the price hike. Taxi drivers are not worse or better off than before since they now pick up fewer customers but get more per customer.

Deadweight Loss

But what is wrong with this equilibrium? Excess supply. At this high price, there are way too many empty taxis on the roads. This is a loss to society (jargon: deadweight loss). Empty taxis are plying the roads when they should be picking up customers. It is an inefficient outcome since precious resources (taxis) are using up precious road space but providing no value to potential customers who might want to use their services if only prices are more reasonable.

I stress however, that this is the benefit of hindsight. Given that fares had been fixed for a long period of time before recent changes, there was previously no telling how consumers would react. In other words, there was too little information on consumer demand. With the benefit of the new knowledge about consumer demand, we now know that current prices are set too high to clear the market, resulting in the inefficient use of resources.

Bring Prices Down

Obviously, we cannot return to the old price level of Pl since it will create the same excess demand as before. However, there are obvious benefits from lowering prices from Ph. Firstly, consumer surplus would increase since there will be more passengers filling the empty taxis. Secondly, if you look at diagram above, setting a price between Ph and Pl may actually increase the revenue of taxi drivers since the area characterised by price times quantity increases*.

Therefore if the situation of excess supply persists, taxi companies should consider bringing the price down.

* Except in the case where the demand curve is unit-elastic. Taxi takings will remain constant if that is the case but still, consumer surplus will increase.

28 Comments:

  • Looks like Sinkie cabbies is not going the way of your fav london ones :-p

    According to wild, unsubstantiated rumours, those with lobangs are doing very well while the majority of the honest, rule abiding ones (i.e those most likely to vote for PAP) are getting what they wanted\deserve.

    NoName

    By Anonymous Anonymous, at 1:58 am  

  • Hi Noname,

    No no, you may have misunderstood me. I support the fare increase - I always felt that prices were too low previously.

    But now that the high fare has caused excess supply, it might be beneficial to bring prices down a little.

    By Blogger Bart JP, at 9:56 am  

  • Bart,

    I think your model is overly simplistic.

    There is a temporal dimension to the problem. During some times of the day, demand is sky high. Other times, taxis go empty.

    Solution to the problem is non-trivial. :-)

    By Blogger kwayteowman, at 11:03 am  

  • Hi KTW,

    Indeed non trivial. To in my defence, I did say I ignore several important factors such as different demands at different time of the day.

    But a telling piece of information is that taxi drivers did not see any change in average takings. The niggling suspicion is therefore that the fare rise was too much. Lower a little (though obviously not back to before) and perhaps every one - both consumers and drivers - will be better off.

    By Blogger Bart JP, at 10:14 pm  

  • The supply side is not so inelastic and taxi drivers can actually leave the profession.

    There is deadweight - I saw 30 taxis at Bugis for a queue with 3 people.

    I believe the solution is from the supply side. Rentals for taxi drivers should be lower by setting up a no-for-profit co-op. Right now the rental is too high and taxi companies control a limited number of licenses, there is no real competition because there is one dominant player.

    By Blogger LuckySingaporean, at 8:04 am  

  • I suggest another potential way of addressing this problem.

    How about eliminating taxi booking surcharge and impose surcharge on flagging down taxi instead?

    This will enable the taxi companies to gain almost full information on the taxi demand and advise their cabbies accordingly.

    This will reduce fuel wastage as the taxi drivers will have less need to drive around spore in search of customers.

    However in order to implement this new scheme the taxi booking system needs to undergo a major upgrade in order to handle the huge increase in the no. of ppl booking cab.

    By Blogger at82, at 7:00 pm  

  • Lucky,

    I actually disagree with you somewhat. I am a firm believer in competition, but co-operative is not the way. What is so special about taxi as a form of service that we need to set a co-operative? Taxi service is just like any other service in the market with consumers and suppliers. We cannot possibly solve every rising cost problem through forming yet another non-for-profit co-operative. It just does not make sense in a free-market economy.

    Besides, the price of taxi must be realistic in relation to other goods. Taxis do take up road resources, cause pollution and cause congestion. Its benefits, once flagged down, accrues solely to the private passenger. I don't think there is a convincing case for taxi fares to be kept artificially low.

    By Blogger Bart JP, at 9:56 pm  

  • AT,

    I am actually in some agreement with what you say. I think we should have a system that depends less on booking fee but more on flag down and metered fare. My experience is that booking fee is subject to abuse.

    However, booking does have its important role to play. For example, you may need to book a cab in order to get to the airport, attend an important function where you need a firm control of time. One way to prevent booking abuse is that booking can only be accepted at least X hours in advance. This will allow those with genuine booking need to book, but at the same time prevent taxi drivers from abusing the system by not picking up passengers unless pre-booked.

    But these issues are complicated admittedly. My main point is still that recent price hike may have been too much, resulting in deadweight loss.

    By Blogger Bart JP, at 10:04 pm  

  • So the best solution is to breakup the big operators dominance and bring back the yellow tops and let taxi drivers give out their namecards, offer additional services (tour guide/pimp/etc)? Free competition at its best?

    Btw, strange that u mention Taxi rates are artificially low while ur dear uncle could make good living ... maybe he can offer courses on how to be a profitable cabbie?

    NoName

    By Anonymous Anonymous, at 1:57 am  

  • He says - be honest, don't wait for calls, don't shirk, just drive and pick up your customers as they come.

    By Blogger Bart JP, at 5:04 am  

  • IMHO you're ignoring the main root of the problem.

    That is: there's a taxi shortage at certain areas (city) at certain times of the day. The shortage is usually more acute just before the midnight surcharge kicks in.

    (Unless you've never read about the numerous stories where empty taxis just zoom pass by potential passengers, or have their "on-call" signs magically changing to "available" once the clock strikes midnight.)

    Now they have given these people more reason to wait till midnight (surcharge went from 10% to 50% immediately @00:00) and a 35% peak hour surcharge to abuse!

    The existence of call booking and surcharges adds to the problem. The existence of ERP (which has to be footed by the driver if he drives into the city with no passenger) makes it even worse.

    With the situtation we have in Sg right now, there is hardly any competitition between the entities - Taxi Companies that benefit most from it.

    ComfortDelgro raised its price, then implored that the other companies follow suit. (Read their press release) And the rest complied. What kind of competition is that? Only in Sg a company can say with a straight face: "We are raising our price to be more competitive!" (Like what NETS did).

    Your uncle is a good taxi driver who does not try to abuse the system. Maybe you should ask him if his income has really gone up by 10% in average (as quoted in the news from ComforDelgro source)

    By Anonymous amused, at 3:02 am  

  • Amused,

    Funny enough, and you may not believe it. Imagine the previous situation - taxi drivers abusing the call booking system by refusing to pick up flag-down passengers. So consumers end up paying the booking fee. Nevertheless, this is actually a welfare transfer from consumers to taxi-drivers. If prices Pl is too low, there will be excess demand. It is not unusual for a black market to develop. The booking fee acts like a black market premium, that is, taxi drivers extorting more from the consumers because they have the bargaining power with excess demand. But since this is a transfer from consumers to drivers, there isn't actually a lot of deadweight loss (except maybe the phone charges on calling!).

    If you want to kill the black market, you must let price rise to choke off the excess demand. There is no two way about it. But my point is that recent price hike may have gone too high, creating real deadweight loss of suboptimal number of transactions given the number of taxis we have on the road.

    By Blogger Bart JP, at 5:01 am  

  • raising the price to kill of the black market is just one of the ways. Not the only way.

    You can remove the booking fee in city so that there is no black market. This will reduce their incentive to pick up calls. Cabs in town would definitely not circle around and not pick up customers.

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