There are two different ways of looking at markets: metaphorically
and as "platforms." Metaphorically, markets are ways of
characterizing transactions between a group of buyers and sellers for a given
product, in a geographic location, and during a specific time. There is
no literal marketplace, but prices and quantities behave as if there
were.
Platforms are literal markets that are under the control of a market maker,
like Uber, who can set different prices to buyers (riders) and sellers (drivers). For
example, suppose that there were seven sellers with marginal costs
{$1,$2,$3,$4,$5,$6,$7} and seven buyers with values={$7,$6,$5,$4,$3,$2,$1}.
Uber makes money on the spread between what it receives from riders and what it
pays to drivers. With these supply and demand curves, we show Uber’s profit calculus below.
Margin

Quantity

Profit

(71)=6

1

6

(62)=4

2

8

(53)=2

3

6

(44)=0

4

0

·
If Uber paid $1 and sold at $7, it would sell one ride
for a profit of $6.
· If Uber paid $2 and sold at $6, it
would sell two rides for a profit of $8.
·
If Uber paid $3 and sold at $5, it would sell three
rides for a profit of $6.
·
If Uber paid $4 and sold at $4, it would sell four
rides for a profit of $0.
The profit maximizing prices are in red above. The table also shows how the competitive
equilibrium (a single price) is actually a special case of the platform with
zero margin.
This raises an interesting question, “is it ever
profitable to bring an extra driver into the market?” In this simple example, the answer is “no.”
However, the answer changes if bringing more
drivers into the market increases the rider’s value for rides by
reducing the waiting time. For example, suppose that an extra unmatched driver
into the market reduces waiting time by enough so that it increases the
willingness to pay by every rider by $2, i.e., with values={$9,$8,$7,$6,$5,$4,$3}. This would change the profit calculus as
follows:
Margin

Drivers

Riders

Profit

(92)=7

2

1

7

(83)=5

3

2

10

(74)=3

4

3

9

(65)=1

5

4

4

·
If Uber paid $2 and sold at $9, it would sell one
ride for a profit of $7.
·
If Uber paid $3 and sold at $8, it would sell two
rides for a profit of $10.
· If Uber paid $4 and sold at
$7, it would sell three rides for a profit of $9.
·
If Uber paid $5 and sold at $6, it would sell four
rides for a profit of $4.
With an extra unmatched driver, the margin
that Uber can charge increases by $2, which is enough to offset the cost of
bringing an extra driver into the market.
In fact, these kind of “network effects” work in both directions. Just as
bringing more drivers into the market reduces the waiting time for riders
(increasing demand), so too does bringing more riders onto the platform make it
easier for drivers to find nearby riders (increasing supply).