Surge Pricing in the Age of AI: Fairness or Exploitation?

When you’re hungry, your demand for food rises due to the demand determinant of consumer tastes and preferences.  Although you would be willing to pay more for food in that moment, you usually get it for the same price every time.  In market economies, the market demand and market supply set the market-clearing, or equilibrium, price.  Some consumers get a good deal because they are willing and able to pay more, but get to buy it at the equilibrium price instead.  These consumers enjoy consumer surplus, or the area above the equilibrium price but below the demand curve.

A wealthy consumer like Elon Musk or Jeff Bezos, two of the wealthiest people in the world, almost certainly would be willing and able to pay significant sums for a slice of pizza or hamburger when hungry after a morning of hard work.  They enjoy lots of consumer surplus, however, when they get the pizza or burger for the same price as you or me.  But what if they didn’t get to enjoy that consumer surplus?  What if firms could charge these wealthier customers the maximum that they were willing to pay?

Surge and Dynamic Pricing Explained

Years ago, firms listed their prices on signs or paper, which cost money to produce and distribute.  These were menu costs and, to some degree, they limited inflation by reducing the ability of sellers to adjust their prices.  Market prices were slower to adjust to changes in supply and/or demand because it took time for sellers to re-print prices.  Today, however, most prices are only listed electronically on apps, websites, or electronic signs or menu boards.  These can be adjusted by the seller within seconds.  This has created a new era of dynamic pricing.

Simply put, dynamic pricing involves adjusting prices in real time after analyzing multiple factors, including changes in consumer demand.  This has led to surge pricing for some goods and services that had fluctuating demand throughout the day.  For example, restaurants have long known about “peak hours” of demand for each meal…why not raise prices during those hours to increase revenue?  With prices being electronic, they can now do so without needing to print new menus or signs.  Similarly, ride share apps like Uber and Lyft, which were always electronic, raise prices for rides during rush hours.  Consumers’ demand is increased during this time, meaning they will tolerate higher prices.  Sellers enjoy greater profits, as their costs of production remain the same.

Debate Over Dynamic and Surge Pricing

Not surprisingly, many people dislike dynamic pricing.  Their key argument is that it unfairly subjects consumers to higher prices during hours of peak demand.  They call it “price gouging”, which is illegal - but only for certain goods and services in the aftermath of declared disasters.  Legally, it’s okay to raise the price of hamburgers or Lyft rides.  Arguably, however, dynamic and surge pricing harm lower-income people more, as they lack the flexibility to adjust their schedules to avoid higher prices.  Wealthier consumers, who often have white collar jobs without set shifts, have more options in terms of substitutes.

Supporters of dynamic pricing argue that it reduces shortages and increases economic efficiency.  When price rises, only consumers who value the good or service sufficiently will continue to purchase.  Essentially, during the surge of demand, the good or service is being put to better use and not being “wasted” on a customer with less need for it.  For example, if a businessperson has an important meeting downtown during rush hour, he or she will pay the surge price for an Uber.  Someone who just wants to browse the downtown shops will likely do something else instead, not wanting to pay the surge price.  This frees up the Uber for someone with more pressing transportation needs.

AI and Dynamic Pricing: Price Discrimination Fears

Current dynamic pricing looks at macro-level factors in the market.  It allows firms to capitalize on higher overall consumer demand, but not the demand of each consumer.  Wealthy customers like Elon Musk and Jeff Bezos still get their goods at the dynamic equilibrium price.  But, could artificial intelligence (AI) used by sellers evolve to the point where it analyzes individual customers and adjusts price accordingly?  

The legality of such price discrimination is questionable, at least at the same location.  Theoretically, however, firms could adjust prices at each location and argue that the location causes their costs of production to differ.  Currently, price discrimination in different venues is legal if the business can justify that there are differences in production costs.  Using AI, a seller could easily determine which locations have wealthier clients and raise prices at those venues.  Of course, once customers realize they are paying more at that location, they will seek lower-cost substitutes.

Online, price discrimination would likely be far more rampant, as AI could quickly glean financial information about each customer based on their Internet history.  It would be difficult for customers to determine they were being charged higher prices, as they would have to compare the same item at the same time with another customer on that customer’s browser.  Sellers would almost certainly not announce their use of AI in setting prices, leaving it up to consumers to determine whether they were facing individualized price discrimination.

Economic Concerns About AI Price Discrimination

Perfect price discrimination would lead to every consumer being charged the maximum amount that he or she was willing to pay.  This would have severe economic harms in the long run by discouraging anyone from attempting to increase their compensation.  Workers would not strive to receive raises or promotions, and entrepreneurs would not strive to create successful start-ups.  It would become pointless to earn higher incomes, as those higher incomes would quickly become neutralized by AI-driven price discrimination.  Therefore, why not enjoy more leisure time and still be able to access the same goods and services at lower prices?

Eliminates the Benefits of Marginal Productivity Theory

Free market economies thrive because most individuals have an incentive to increase their productivity to increase their income.  Price discrimination can violate this principle, resulting in no incentive to increase productivity.  Millions of workers would say “why bother?” when given a chance to compete for a raise or promotion, preventing economic growth.  Although unlikely, if AI price discrimination gave lower prices to those whose income fell, society might even see a wave of people exiting the labor market.  After all, if you can get goods and services for pennies on the dollar, why work at all?  A person with zero income could, at least theoretically, take advantage of AI by accessing the same goods and services for almost zero price as the system automatically recalibrates for his or her lack of income.