{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Copy+From+incentives+books(useful pt midt_1)

# Copy+From+incentives+books(useful pt midt_1) - Equilibrium...

This preview shows pages 1–2. Sign up to view the full content.

Equilibrium, Efficiency, and Asymmetric Information I TAXI! You have just landed at the airport in a city that you are visiting for the first time. You hail a cab to take you to your hotel. How can you be sure that the driver chooses the quickest and cheapest route to your destination? You can't, unless you make an investment beforehand; an investment of money to purchase a map and of time to compute the shortest route between your departure point and your destination. Even then, you will not know which streets are normally congested, so it would be very costly to discover the cheapest route. Assuming that you are not prepared to incur that cost, is there any way of ensuring that the taxi driver will not take you out of your way to enhance his or her income at your expense? We need to find a way of providing the driver with an incen- tive to choose the least-cost route, so that even though you don't know what that route is you will be sure that the driver has chosen it because that choice maximizes the driver's return from operating the cab. This is the purpose of the fixed part of the nonlinear pricing schedule for taxi rides. The fare is F + cD where D is the distance to your destination in miles, c is the charge per mile, and F is the fixed initial fee which is independent of the length of the ride. (In fact, you will be charged for time spent idling in traffic, but let's keep things simple.) If F is zero, and hence the fare is cD, then the driver has a strong incentive to make each trip as long as possible. That's a consequence of the fact that when passengers are dropped off at their destinations, it takes the taxi driver time to find a new passenger. On one hand, from the driver's standpoint, it would be better to keep the meter running by keeping the original passenger in the cab, and that requires taking a much longer route than necessary. On the other hand, if the fixed fee is relatively large-say \$3.00 when the average variable cost per ride is \$6.00-then the driver has a strong incentive to maximize the number of trips per day. But maximizing the number of trips per day can be accomplished only by making each trip as short as possible. Example 2.1: The linear fare induces shirking F = 0 and c = 1. Hence the fare is equal to D, the distance of the trip. To simplify, each trip is 5 miles long when the taxi driver takes the short route, and the long route is 10 miles long. The driver can make 30 trips a day of 10 miles each or 55 trips a day of 5 miles each. (Remember, time is lost between trips.) When the driver works efficiently her revenue is 55 x \$1 x 5 = \$275. But when the driver shirks, and takes the long route, her daily revenue is 30 x \$1 x ] 0 = \$300: She makes more money by shirking. The linear fare schedule (with

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 7

Copy+From+incentives+books(useful pt midt_1) - Equilibrium...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online