Let’s play a game.
Turn to the most finance-savvy person you know. Maybe it’s a relative who’s memorized The Total Money Makeover. Maybe it’s a colleague who waxes poetic about compound interest in investments. Maybe it’s a friend who gains an unnatural amount of pleasure when browsing personal finance blogs. Whoever that person may be, I invite you to ask them: what side hustle do you recommend?
Perhaps you’ll get “part-time job” (yawn), “babysitting” (double yawn), or “online surveys” (puh-leeze). But maybe, if they’ve stayed up-to-date in the personal finance world, you’ll get “Airbnb” (screams and falls off chair).
Either work, really. But my point is, anyone who knows anything about side hustling knows that you gotta take advantage of what you’ve got. For side-hustlers like us, the sharing economy has been a blessing – so easy! So convenient! So many additional sources of income!!!
It seems too good to be true – and critical thinkers (*adjusts monocle*) always get a little tingly when that phrase pops up. It’s time to take off the rose-coloured glasses (or monocle) and look at the sharing economy for what it really is.
It’s pretty impressive, actually. I like it.
The Sharing Economy: The Good, the Bad, and the Definition (not in that order)
So first things first – what’s this “sharing economy” thing? At first glance, it sounds a bit like a summer camp activity where the counselors put all the kids in circle, make them hold hands, and sing cheesy rhymes.
Is it just me? Yes? I should move on?
The sharing economy isn’t anything like that (thank goodness). It basically refers to a model/system where people can rent/borrow things from each other – hence my Airbnb intro. Airbnb and Uber are both really good examples of transactions that happen in a sharing economy.
Now, I know what you’re thinking. But Sophie! you may exclaim, pressing your palms against your cheeks, I thought we had a capitalistic economy?
If you’re feeling a wee bit distressed at this shift in your worldview, I don’t blame you. I had to do some Google sleuthing myself. But basically, the way it works is that capitalism is a system. It just tells people “hey, if you’ve got bread and someone else wants bread, you can sell it to them. Price? Don’t care. Want to make cheese instead? Be my guest.” Meanwhile, an economy is more like an economic system or a series of transactions in a certain category.
Okay, I went off on a bit of a tangent there, so recap: sharing economy. If Sam has a lawnmower, the sharing economy would allow him to rent it out to Susan, who doesn’t have a lawnmower. This way, Susan doesn’t have to buy her own lawnmower, and Sam gets some cash for a thing that was sitting in his shed.
Now let’s move on to the nitty-gritty stuff.
Brief disclaimer: for the rest of the post I’m going to be talking about people like they’re firms or businesses (which, in the sharing economy, they kind of are).
When talking sharing economy, there are a few different perspectives to look at. I’m going to go small and slowly move up, so I’ll start by talking about individual effects before moving on to government regulations, business and big-picture effects.
The benefits to the renter are obvious. If we assume that, like regular firms, the goal of the individual is to maximize their profit, then the sharing economy allows individuals to increase their productivity. Only, instead of increasing output like a traditional firm, the individual takes advantage of already-existing output production methods. The rising prominence of the sharing economy has been a wake-up call, like an annoying friend who’s slapped you and pointed to all your underutilized assets in frustration, screaming “Why are they just sitting there?!?!”
The sharing economy lets people fully maximize output from the resources they have available, even if the resources in question are usually capital (cars, anyone?). So while the ultimate result is the same (an increase in revenue), the sharing economy lets the individual do this in a way that barely changes fixed costs.
Take this guy, for instance. He made an extra $30,000 in revenue over 2 years, simply by realizing he’d been performing inside his PPC. Over half of this revenue was from Airbnb, generated by a guest room that was collecting dust. All of a sudden, the opportunity cost of that dust-collecting room was the money he could be earning by renting it out. He didn’t just move along his PPC – he redefined it. The entire curve shifted outwards as he became conscious of resources he didn’t know he had. He was just doing what he normally did and earning money for it:
Even before I was hosting on Airbnb, I still had to take the time to keep my house clean. These days, I still keep my house clean… In a way, it’s like I’m paying myself to keep my own house clean.
This isn’t an isolated incident, either. In San Francisco, Airbnb hosts rent out their homes for an average of 58 nights per year, generating about $9,300 in revenue.
Essentially, the sharing economy benefits the renter because it brings in additional revenue – an economic incentive.
The benefits to the consumer, on the other hand, are equally obvious. Let’s go back to Silicon Valley for a moment. The average hotel room in San Fran is close to $400/night (*wheeze*). Extrapolating from the data above, the average Airbnb accommodation is $160/night ($9,300/58).
I know. The consumer surplus is dizzying; $240/night ($400 – $160) is nothing to scoff at.
But wait! There’s more!! I haven’t even begun cracking down on the sweet stuff – and by sweet stuff, I mean the cons of the substitute good (same thing, right?). You see, hotel rooms aren’t just more expensive – they’re more wasteful, too. By choosing Airbnb over hotels, consumers dodge around 1 kg of waste per night in addition to enormous energy savings. After all, renters don’t expect the host to vacuum and change the sheets every night.
These incentives apply to everything in the sharing economy (be still, my heart). In renting a neighbor’s lawnmower, you save on both the cost of buying one yourself (economic incentive) and the environmental ramifications of lawnmower production (moral incentive).
So there are economic and moral incentives to the sharing economy. There can’t possibly be social incentives, can there? Can there??? Can there?!?!?!?!
You may want to sit down for this.
What’s one of the most common reasons people use Airbnb? Sure, saving money’s one, but meeting people is another. Turns out, if someone’s visiting a new place, they enjoy interacting with a local (wow). This is put very nicely by Brian Chesky, co-founder of Airbnb:
There is a whole generation of people that don’t want everything mass produced. They want things that are unique and personal.
Is there anything more unique than a treehouse in Orlando? More personal than a car tailored to your group size? Plus, it’s so hip to rent things now, haven’t you heard?
Of course, this doesn’t apply to every transaction. Renting out a parking space to someone isn’t as personalized as dog-sitting. But the fact is that some transactions are much more personalized than their traditional counterparts. Consumers are lured in by all three types of incentives (or sometimes two), and locked in with the experience of total utility (full consumer satisfaction).
Alas, perfection is not a thing that exists in this world. Individuals on both sides of the transaction don’t always benefit completely (or even at all).
Warning: Math Ahead. Proceed with Caution.
Say you’re an Uber driver in Detroit and want to know whether it’s actually profitable. According to this report published by Buzzfeed News, you’re likely to earn an average of $12.70/hour before expenses. Taking the average speed limit for Detroit (35.1 mph), we find that the driver makes around $0.36/mile. Considering account asset depreciation, price of gas, and insurance/repairs, this comes out to $8.77/hr after expenses – $0.48 less than minimum wage.
The basic numbers are:
- Revenue: $12.70/hour
- Marginal revenue: $0.36/mile
- Marginal costs: $0.17/mile
- Average total cost: $5.95
I know that $12.70 minus $5.95 does not $8.77 make, but remember that there are adjustments since drivers aren’t driving at 35.1 mph the entire hour.
Uber driving especially is a good example of the diminishing returns effect, and a somewhat good example of the spreading effect. The sharing economy is rich in both – you’ll see why.
Assuming you own the car you’re driving, the more you drive the more miles you accumulate and the more worn-down your car gets. As a depreciating asset, the more you use, the less its worth – hence the high marginal costs listed above. The variable costs involved here include the rising prices of gas and miscellaneous repairs that could result from frequent driving (ie. headlights going out). Meanwhile, the more you drive, the more ratings and reviews you accumulate on the Uber app, increasing your revenue. However, the spreading effect isn’t present to the point where it offsets the diminishing returns effect, making the lucrativeness of Uber driving dependent on revenue.
But let’s take a look at the consumer side of things. Here, the main con is the government’s (lack of) presence in the sharing economy.
The Government and the Sharing Economy
Peer-to-peer transactions that occur within the sharing economy aren’t as regulated compared to business-to-individual transactions. Sharing economy transactions have a reputation for missing customer protection. After all, the businesses involved don’t pay as much for background checks and insurance since there are so many contracted individuals.
But there are some things that are handled well! Because it’s unfair to regulate Airbnb hosts like motels, cities sometimes impose an occupancy tax. It’s a tax on the rental of rooms that the local government collects. Or, rather, Airbnb collects the occupancy tax and forwards it to the government. This means that local authorities don’t need to run around and track down every Airbnb host in the area – overall, a pretty good solution! Of course, there’s still the problem of illegal Airbnb hostings, which is why some places have banned Airbnb entirely.
Speaking of taxes, did you know that Uber’s actually created something called a tax shell? It’s exactly what it sounds like: a form of protection against paying taxes. Apparently, tax shells are all the rage in Silicon Valley; Facebook and tons of other companies were in the bandwagon long before Uber. By setting up daughter companies in foreign countries with different tax laws, an enormous amount of accounting profit from international markets can evade taxation. It’s not technically illegal, and it’s not like the national government can do anything about it; you can’t just tell a company not to expand.
But when it comes to sharing economy transactions that don’t operate via businesses, like the oft-used neighborly lawnmower rentals, the government doesn’t really tax transactions. In an economy that has an estimated $26 billion in value, even a small amount of untaxed transactions could have a big impact. Also, those informal transactions aren’t often regulated. You could agree to rent a lawnmower from someone only to see it and realize it’s one of those hand-push ones that has rusty blades – still technically a lawnmower, but something that leaves you feeling like you’ve been scammed. If you’d bought a lawnmower from Home Depot, they wouldn’t have gotten away with such a crummy product.
Furthermore, it’s hard to pin down which industries these sharing economy businesses lie in, which complicates which regulations they need to comply with. Uber, for example, is a technology platform. The business itself isn’t part of the transportation industry, but its independent contractors are. As a result, since the Americans with Disabilities Act only applies to transportation companies, Uber considers itself exempt. The government hasn’t stepped in, and it looks like they aren’t going to anytime soon.
It seems that the problem lies in the fact that, yet again, the world has advanced faster than government policies (*sigh*).
Businesses and the Big Picture
Most businesses in the sharing economy offer economic incentives to consumers; they have lower prices than traditional services. Unlike a traditional pricing-out of competition, which is how an oligopoly stays an oligopoly, businesses in the sharing economy don’t need to make any improvements to productivity or efficiency to lower costs. I’m sure we’ve all heard of taxi companies’ decline in revenue (thanks, Uber). In relying on the general populace to provide the good/service, sharing economy businesses have lower fixed costs. This causes lower marginal and average total costs, leading to the substitution effect that makes people switch from taxis to Uber.
Actually, the taxi/Uber thing is pretty interesting. You see, Uber actually filled a shortage in the market – a purposefully created shortage that restricted the number of taxi medallions on the market for the sake of congestion. Society used to experience deadweight loss, as we lost the benefit of the cab rides that would’ve happened had the number been unrestricted. So the surge in Uber isn’t just because it’s cheaper than a taxi – it’s because supply is suddenly meeting demand. The sharing economy’s actually bringing supply and demand closer to an equilibrium point, which is pretty darn neat.
There’s one last economic advantage to the sharing economy: it’s local. In having revenue be funneled into individuals rather than businesses, money can be effectively re-circulated in the local economy. Instead of consumer payments going to the CEO of Hilton, it’ll be going to someone like a single mom renting out a room on Airbnb. That mom will experience a greater amount of purchasing power as her income grows (wow, a demand determinant!). That money’ll stay in the city she lives in and be redistributed to other citizens, growing the local economy.
The Ultimate Conclusion?
So, the rose-coloured glasses have come off, and they’re staying off. After all those words, all that research… so what? What’s the verdict?
- Supplier gets an increased revenue (and increased purchasing power), benefiting the local economy
- Consumer gets a nice consumer surplus along with economic, moral, and social incentives
- Supplier isn’t guaranteed to make above minimum wage; high marginal costs
- Consumer may not always get the best quality product due to lack of government regulation
- Businesses suffer from lower-priced competition
Even though the pros outnumber the cons, I still think that the sharing economy is beneficial. It provides excellent opportunities for individuals to both make and save money, the importance of which cannot be understated. An Airbnb listing might be the extra revenue needed for the host to funnel money into savings, or help pay off their mortgage. It empowers individuals to become more financially independent, which is critical in today’s debt-ridden world. It might not be a good primary source of income but hey, side hustles, anyone? It also helps local economies and keeps circulation within the community, which I am all about. Also, the consumer surplus involved in some of these transactions is incredible, meaning that people can redirect those funds to things that matter to them, whether it’s a trip with friends or paying off student loans.
While there are disputes between new businesses in the sharing economy and their traditional counterparts, I think that some of those disputes are just a result of one of the factors of demand elasticity: time. As time passes, substitutes naturally arise. This is an economic fact, and in a situation where two groups are competing for the same market, basic economic principles will determine which gains the majority and where consumer niches will pop up.
The lack of government regulation is a definite problem, especially the less-than-adequate insurance. But this is normal: advancements happen, mistakes are made, and the government and its regulations wizen up.
(Now if only they could be a lil’ bit quicker about it)