Decoding the Economics Behind Surge Pricing and How It Benefits Taxi Apps

Be it New York or New Delhi, the ‘surge pricing’ system garnered a lot of media attention and has been a hot debate topic in the last few years. On a simple note, surge pricing or dynamic pricing is a tool used by ridesharing companies when the number of ride requests surpasses the availability of cabs in a particular area.
However, there has been a lot of controversy around this pricing tactics when applied to the on-demand taxi services. This blog digs deeper into the surge pricing model and how it affects all stakeholders which include drivers, taxi aggregators, and commuters.

What is Surge Pricing

Dynamic pricing in economics refers to a time-based pricing strategy in which business set flexible prices depending on the market demand. This type of pricing model is used by airlines, hotels, railways, etc. The same pricing model is applied to ride-sharing as well.
Taxi aggregators use a pricing algorithm that maps the demand-supply in a particular area and fix the rate accordingly. As a result, the cab fares rise when the ride request exceeds the number of cabs available in a particular area. At peak times, the on-demand cabs charge 3 to 8 times of the normal fare to cater the needs of the commuter. Also, the surge pricing system works during occurrences like bad weather, festivals, events, rush hour, etc.

How Does Surge Pricing Work?

There have been a lot of speculations over how surging price mechanism works in on-demand cabs. The logic applied is simple. When the supply becomes scarce relative to the demand, the price is multiplied in order to match supply with demand.
In the case of ridesharing, when the requests for cabs are higher than the number of available cabs at a specific location, the user will see a multiplier (2x, 3x, 1.5x etc.) to the standard rates. The multiplier increases as per the demand for the rides in the specific area of the commuter.
The algorithm checks the demand data after a specific time duration and the prices surge until the supply and demand reach equilibrium. Consider the example of Uber, a pioneer among on-demand cab service providers to introduce surge pricing. The automatic pricing algorithm of Uber checks the number of requests and available cabs at the location every five minutes. Whenever there is an imbalance between the number of riders and drivers, the base fare gets multiplied. This way, the cab aggregator is able to quickly connect the rider with the driver and ensure improved efficiency in the market.
Originally Publised at TaxiPulse 

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