Price and Entry Regulation TransportationAnd Regulation of “Competitive” Industries

Price & Entry Regulation Formerly applied to Formerly applied to Railroads Railroads Motor Carriers Motor Carriers Airlines Airlines With deregulation ( ), little used With deregulation ( ), little used Differs from natural monopoly reg. Differs from natural monopoly reg. Non-exclusive licenses/territories Non-exclusive licenses/territories Regulated P > MC Regulated P > MC Eliminate “discriminatory” pricing Eliminate “discriminatory” pricing Promote “universal service” thru cross-subsidy Promote “universal service” thru cross-subsidy Incentive for entry by less efficient providers/substitutes Incentive for entry by less efficient providers/substitutes

Effects If P R > MC 1, then less efficient firms may enter and take whole market at P 2 MC 1, then less efficient firms may enter and take whole market at P 2 <P R P R > P 2 > MC 2 > MC 1 P R > P 2 > MC 2 > MC 1 Must regulate substitutes (Railroads, Trucks) Must regulate substitutes (Railroads, Trucks) Entry may reduce welfare Entry may reduce welfare P > AC, but just enough firms so each produces MES quantity to maximize profit P > AC, but just enough firms so each produces MES quantity to maximize profit Entry then results in P = AC at lower quantity per firm and higher AC Entry then results in P = AC at lower quantity per firm and higher AC “Quality” competition with entry blocked “Quality” competition with entry blocked may raise AC up to P may raise AC up to P but consumers may prefer higher “quality” but consumers may prefer higher “quality” Effect on SW ambiguous Effect on SW ambiguous

Transportation Regulation Railroads Railroads Elements of natural monopoly Elements of natural monopoly Cartelization through capture of regulators Cartelization through capture of regulators No price discrimination (uniform pricing) No price discrimination (uniform pricing) Cross-subsidy creates incentive for entry (trucks) Cross-subsidy creates incentive for entry (trucks) Entry/Exit regulated Entry/Exit regulated No abandonment of unprofitable routes No abandonment of unprofitable routes Value of Service pricing Value of Service pricing Transport rates based on value of goods Transport rates based on value of goods Deregulated under demands of railroads and large shippers in 1980s Deregulated under demands of railroads and large shippers in 1980s

Transportation Regulation Motor Carriers (Trucks) Motor Carriers (Trucks) Substitute for railroads Substitute for railroads Cartelization through Rate Bureaus Cartelization through Rate Bureaus Entry and Exit Regulation Entry and Exit Regulation Likely welfare enhancing under the circumstances Likely welfare enhancing under the circumstances Undermined by growth of contract haulers and vertical integration by large shippers Undermined by growth of contract haulers and vertical integration by large shippers Effectively deregulated by 1990s Effectively deregulated by 1990s

Transportation Regulation Airlines Airlines Originated as subsidy for mail carriers Originated as subsidy for mail carriers Protection from “ruinous” competition Protection from “ruinous” competition Cross-subsidized routes Cross-subsidized routes Promote “universal service” Promote “universal service” Necessitated entry and exit regulation Necessitated entry and exit regulation Quality competition eroded profits while keeping prices high Quality competition eroded profits while keeping prices high Unregulated intrastate routes in TX and CA had much lower prices than interstate regulated routes of similar length Unregulated intrastate routes in TX and CA had much lower prices than interstate regulated routes of similar length Deregulated in 1970s Deregulated in 1970s Carter Administration (Alfred Kahn at CAB; Ted Kennedy) Carter Administration (Alfred Kahn at CAB; Ted Kennedy) Both airlines & passengers saw benefits from competition Both airlines & passengers saw benefits from competition Lower prices better service on high volume routes Lower prices better service on high volume routes Some low-volume routes to small cities were lost Some low-volume routes to small cities were lost