Regulation and asymmetric information

I just got back from a trip to Pittsburgh for a successful thesis defense (congratulations to Dr. Justin Dunmyre) and had an education in taxi cab metering.  On my outbound trip to the airport, by sheer coincidence I left seconds behind another cab going to the exact same destination.  The meter on that cab, which I could see through the window, read about 15% higher than my meter.  On my return trip, the fare on the meter was also much higher than a return fare from just three weeks ago. This led me to think about how meters are calibrated and what disincentive there is for drivers to tamper with them.

When I fly into an unfamiliar city, I get into the first cab available.  In most cases, I have no idea how far the hotel is, what is the optimal route, and what the fare should be.  I must trust the driver completely.   There are so many ways that the driver can overcharge me and I really have little defense.  This is why almost all cities regulate taxi cabs.

I think this is also a perfect example of how competition cannot always ensure the best price.  In any situation where transactions are not repeated, the classic results of the prisoner’s dilemma should apply.  That is to say, it is only rational for the cab driver to defraud the passenger.  It is an asymmetric situation where the driver has all the information and the passenger has none.  Now I’m sure that libertarian leaning economists would argue that repeat customers and intracity users will be sufficient to ensure that cabs are fair.  However, it is not too difficult for the driver to identify who is naive and who is experienced and they can behave accordingly especially for drivers that pick up passengers from hotels and airports, which in many cities is a large fraction of the taxi business.

Now, it is not in the interest of the city to have corrupt taxi cab drivers.  It gives a city a bad reputation and that could discourage tourism, conferences and business.  That is why it is in the interest of the population of the city to regulate taxi cabs.   I do believe that there are cases where regulation only serves as a barrier to entry and discourage competition but in the case of taxi cabs, I’m all for it.

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4 thoughts on “Regulation and asymmetric information

  1. In a ‘free’ market you would negotiate the fare with the driver and there would be no cheating (I mean, besides essentially being mugged by your cab driver). The meters themselves arise from regulatory action.

    This sounds sort of unpleasant on its face, but now that everybody has a smartphone, you should really just have an app where you just say what trip you want to make and different cab companies ‘bid’ to take you. For people with no smart phone, I’m sure hotels and airports could have tablets or some such available for this purpose.

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  2. Suppose we deregulated taxis tomorrow. Do you think such a reverse auction system would arise naturally? Basically, how unique or stable is the “true free market” fixed point?

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  3. It seems like you are arguing that the only two options are (A) the “wild west”, or (B) artificial scarcity of cabs (as determined by permits) with price controls (as determined by a regulatory board). Is there any reason we couldn’t have a free market of cabs, but retain regulators with special expertise in identifying and prosecuting fraudulent cab driver behavior? There are lots of industries with no barriers to entry, which nonetheless have special regulations which impose fair operation requirements, and for which there are people trained to execute those regulations.

    Even without regulators, as John said above, having smartphones is a game-changer and is a disruptive technology to the asymmetric information that cab drivers once had. It is now trivial for each passenger to determine exactly how far they have traveled, and whether the cab driver is taking a reasonable route. I’ve used navigation on my phone while in a cab, and had my driver take what (according to my navigation program) was a non-optimal route. If I thought that this route was deliberately fare-increasing, I would let him know, or take it out of the tip.

    Lastly, as a former Pittsburgher, have you ever used the Jitney service available around town? I used to rely exclusively on the Jitney drivers to do my grocery shopping before I had a car, and had nothing but positive experiences. Despite the fact that it is unregulated (and in some places illegal), it is at each location quite organized. The drivers take turns as if in a real taxi stand, the fares are fixed (but can be negotiated for extraordinary circumstances), and the quality of the ride is about what I’ve come to expect in a regular taxi. Furthermore, the Jitney drivers perform a valuable service for those citizens that live in neighborhoods that real taxis won’t go to.

    Which brings up the last point: a lot of regulations don’t appear to serve any useful purpose other than to prevent people of means from accidentally purchasing inferior goods. But they do so by creating barriers to entry that exclude poor citizens from purchasing those goods, even when they would be willing to purchase inferior goods (being often better than no goods at all). Regulated taxis with fixed prices and barriers to entry ensure a maximum price, but they also ensure a minimum price and a maximum quantity, which may be too expensive and too few to serve all citizens.

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  4. Thanks for your comments. It has certainly made me think more carefully about regulation. I think it is fair to say that what regulation does is to take away an opportunity to fully optimize in exchange for not having to work as hard to get a reasonable albeit suboptimal result. If you are at the far right end of the distribution (e.g. innate ability, economic savvy, education, etc.) then a deregulated society may always be better for you. While it may prevent poor people from purchasing cheaper goods if they have the necessary tools to take advantage of a deregulated system, it also protects them from exploitation. If I get cheated out of a hundred dollars, it’s not that big of a deal but for a person on the margins it could mean not feeding their family that week. I’m sure if medications weren’t regulated I could get much cheaper drugs but would I want that necessarily?

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