By Tim Harford. Excerpt:
"The basic case for dynamic pricing is simple: it’s the same as the
case for the price mechanism in general. In most markets, people are
keen to sell when the price is high and buy when the price is low. And
at the right price, supply and demand match perfectly.
If the price is either too high or too low, then there are missed
opportunities to trade. We might see a queue of eager buyers but
shortages of products to buy.
The most obvious cost of such mismatches is the queue. If I credibly
promised to give away £20 to everyone who formed an orderly line in
Piccadilly Circus, people would keep joining that line until it was so
long that people were being paid £20 to queue for £20 worth of time. I
would have achieved the self-defeating miracle of giving away a small
fortune without managing to help anybody except the lucky few who joined
the queue early.
The same logic applies if I was offering any product or service at
£20 below the market price. The time wasted by the queue incinerates the
potential value of the bargain, and what the seller loses, the buyer
fails to gain.
Of course, not every underpriced product is rationed by queue. Some
are rationed by political or social connections. Some are rationed by
chance. That is also inefficient. Maybe it’s a rainy night, and everyone
would like to get an underpriced taxi home, but only some people also
have the option of catching a bus? Those on the bus route are just as
likely to get lucky with a passing cab as those who face a five-mile
walk in a downpour. If the taxis were more expensive and hence less
scarce, those with the choice of catching the bus would be more likely
to take it.
That is the case for the price mechanism in general. But what’s true
for prices in general is also true for the price of hotels on the
weekend that Taylor Swift is playing a concert in town, of flights on
the first day of the school holidays and of toilet paper in the first
week of a pandemic. If the price doesn’t adjust, then the result isn’t
efficient. Nobody likes to feel that they are being ripped off (so the
haters gonna hate) but a sharp increase in the prices of these products
would immediately produce the kind of adjustments that any reasonable
person would want. If Taylor Swift is playing in Seattle one weekend, it
would be a good idea for people who aren’t Swifties to holiday either
on a different weekend or in a different city.
You can tell a similar story about childless holidaymakers, and for
people who already have spare toilet paper but might as well pick up
more just in case. We are outraged that the price increase squeezes more
money out of people who are keen on Taylor Swift, a late July getaway
or a clean bottom. We tend not to realise that the price surge gently
encourages those who can make alternative arrangements to do just that.
Little rides on the nothingburger question of whether Wendy’s might
vary the price of junk food. But if more supermarkets used digital
labels to vary the price of food, shifting food near its sell-by-date
and warding off shortages of hotly demanded produce, the world would be a
less wasteful place.
And there is a market in which the fate of the planet turns on
dynamic pricing, namely electricity. Electricity demand varies a great
deal depending on the weather and the time of day, and increasingly
electricity supply also fluctuates depending on the sun and the wind.
The cost of offering customers a static price for electricity is
enormous: it requires huge overcapacity in general, and overcapacity of
fossil fuel plants in particular, because gas turbines are well suited
to coping with brief spikes in demand.
Part of the solution is obvious: encouraging electricity users or
their smart devices to draw less power at peak times, and batteries or
other forms of energy storage. The basic way to fund storage? Allow the
battery to buy electricity when it’s cheap and sell it back to the grid
when it’s expensive. All this is much easier with dynamic pricing. We
have a planet to save, after all."
