Price and Entry Price and Entry RegulationRegulation

TransportationTransportation

AndAnd

Regulation of “Competitive” Regulation of “Competitive” IndustriesIndustries

Price & Entry RegulationPrice & Entry Regulation Formerly applied to Formerly applied to

Railroads Railroads Motor CarriersMotor Carriers AirlinesAirlines

With deregulation (1976-1990), little used With deregulation (1976-1990), little used Differs from natural monopoly reg. Differs from natural monopoly reg.

Non-exclusive licenses/territoriesNon-exclusive licenses/territories Regulated P > MCRegulated P > MC Eliminate “discriminatory” pricingEliminate “discriminatory” pricing Promote “universal service” thru cross-subsidyPromote “universal service” thru cross-subsidy Incentive for entry by less efficient Incentive for entry by less efficient

providers/substitutesproviders/substitutes

Effects Effects

If PIf PRR > MC > MC11, then less efficient firms may enter , then less efficient firms may enter and take whole market at Pand take whole market at P22<P<PRR PPRR > P > P2 2 >> MC MC22 > MC > MC11 Must regulate substitutes (Railroads, Trucks)Must regulate substitutes (Railroads, Trucks)

Entry may Entry may reducereduce welfare welfare P > AC, but just enough firms so each produces MES P > AC, but just enough firms so each produces MES

quantity to maximize profitquantity to maximize profit Entry then results in P = AC at lower quantity per firm Entry then results in P = AC at lower quantity per firm

and higher ACand higher AC ““Quality” competition with entry blockedQuality” competition with entry blocked

may raise AC up to Pmay 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 Transportation Regulation

RailroadsRailroads Elements of natural monopolyElements of natural monopoly

Cartelization through capture of regulatorsCartelization 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 regulatedEntry/Exit regulated

No abandonment of unprofitable routes No abandonment of unprofitable routes Value of Service pricingValue of Service pricing

Transport rates based on value of goodsTransport rates based on value of goods Deregulated under demands of railroads and Deregulated under demands of railroads and

large shippers in 1980slarge shippers in 1980s

Transportation RegulationTransportation Regulation

Motor Carriers (Trucks)Motor Carriers (Trucks) Substitute for railroadsSubstitute for railroads Cartelization through Rate BureausCartelization through Rate Bureaus Entry and Exit RegulationEntry and Exit Regulation

Likely welfare enhancing under the Likely welfare enhancing under the circumstancescircumstances

Undermined by growth of contract haulers Undermined by growth of contract haulers and vertical integration by large shippersand vertical integration by large shippers

Effectively deregulated by 1990s Effectively deregulated by 1990s

Transportation RegulationTransportation Regulation AirlinesAirlines

Originated as subsidy for mail carriersOriginated as subsidy for mail carriers Protection from “ruinous” competitionProtection from “ruinous” competition

Cross-subsidized routesCross-subsidized routes Promote “universal service”Promote “universal service” Necessitated entry and exit regulationNecessitated entry and exit regulation

Quality competition eroded profits while keeping prices Quality competition eroded profits while keeping prices highhigh

Unregulated intrastate routes in TX and CA had much lower Unregulated intrastate routes in TX and CA had much lower prices than interstate regulated routes of similar length 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 Both airlines & passengers saw benefits from

competitioncompetition Lower prices better service on high volume routesLower prices better service on high volume routes Some low-volume routes to small cities were lostSome low-volume routes to small cities were lost