2/27/2006

Price Ceiling

In this post about the recent transportation crisis in New York, an ineffective price ceiling was discovered. The article states that during the transportation crisis, the city authorized cab drivers to increase their rates up to $5 per ride, from the standard price of $2. Cab companies chose not to change their prices however, in fear that it would offend their regular customers. This is an example of a price ceiling being set higher than the equilibrium price, making it ineffective.

3 comments:

Blake said...

This action seems like a complete waste of time for regulators. Rather than handsomely capitalizing in the process, I believe drivers would end up just losing business and revenue. Plus, from the link, it sounds like drivers ignored the attempted price hike anyway, making the implementation of a price ceiling for transportation a major failulre.

Billy said...

I agree with your observations. I think that the price ceiling was worthless because the drivers were unwilling to raise their prices. The intentions behind the raise in prices were good, but it seems like they just ended up going unnoticed.

Dr. Tufte said...

Umm ... folks ... this is a price floor not a price ceiling.

Yes, it was probably ineffective because it was set too low.

Also, the taxis have a two part pricing scheme: $2 for minimal service, plus a marginal price on top of that. You wouldn't expect that to make too much difference if most rides are more than $5 (which they are).

The economics of the refusal to use the $5 charge make a lot of sense. Consider the situation: that taxicabs have a monopoly, with marginal costs per ride that are approximately constant. Assume demand is linear, as in P=a-bQ. Then revenue is aQ-bQQ, and marginal revenue is a-2bQ. The profit maximizing quantity is where marginal revenue equals marginal costs c (assumed to be constant). Solve this for Q to get Q = (a-c)/2. Substitute back to get P = (a+c)/2. Now, in this linear demand, a is the marginal benefit of the person who needs a cab the most, while b captures something akin to the elasticity of demand with respect to price. A transit strike isn't likely to change a (the marginal benefit of, say, a woman in labor taking a cab to a hospital). But, a transit strike is likely to reduce b as demanders become less sensitive to price. The question we want to address here is how sensitive is price to b. The answer is not at all. Thus, a transit strike isn't likely to increase the price of cabs because two effects cancel out: the increased willingness to pay for a cab, and the decline in markup over marginal price that occurs when demand becomes less inelastic. Neat, eh?