Regulation

Stages of regulation, continuous cycle

Market failure Safety Inability to provide service Monopoly or oligopoly Entry Need for social justice

New technology or methods and make regulation less relevant

Deregulation

Historical phases of regulation Anti-monopoly phase pre – 1930 Anti-competitive phase 1900 – 1945 Central control 1945 – 1950s Creation of controlled competition 1950s –

1970 Deconstruction of regulatory framework

1970 – 1980 The age of regulatory reform 1980 – 2001 Re-introduction of regulations???? 2001 -

future

Modern day regulator issues Contracting for services previously provided by civil

servants Service contractors providing all kinds of public work

services Security services, fire and military

Ownership and fee collection of prior public sector exclusive Design-build arrangements Private sector finance of road construction Private maintenance or roadways Private sector operation of transportation facilities Private sector ownership of transportation facilities

Pricing and safety regulation of private facilities

Justifications for regulations Economic monopoly power The control of excessive competition The regulation of externalities The provision of public goods The provision of high-cost infrastructure The assistance of groups in need of transportation The existence of high transaction costs The integration of transportation into wider economic

policies The need to reflect the genuine resources costs of

transportation The improvement of transportation coordination

Applying regulation

The application of regulation most often covers more than one purpose an therefore it may be more appropriate to discuss regulatory instruments.

Regulatory instruments Taxes and subsidies Direct provision Laws and regulations Competitive polic and consumer protection Licensing The purchase of tranportation services (the mail

services) Moral suasion (advertising seat belts) Research and development (ITS) Policy regarding inputs (our middle east policy has

much to do with transportation fuels)

Railroad regulation

Justification – To prevent unreeasoable prices and earnins in situations where technology and demands create natural monopolies.

To prevent discrimination among groups with unequal bargaining power.

Granger revolt Through the 1970s – the granger

movement created a call for equity among rates States tried to regulate railroads

In 1987 Created the Interstate Commerce Commission (ICC) Shipping rates had to be "reasonable and just" Rates had to be published Secret rebates were outlawed Price discrimination against small markets was

made illegal.

ICC Hepburn Act of 1906 and the Mann-Elkins Act of 1910

strengthened the ICC The Hepburn Act empowered the ICC to change a railroad

rate to one it considered "just and reasonable," after a full hearing of a complaint.

The Mann-Elkins Act placed the burden of proof on the railroads; for the first time, they would have to actively demonstrate that a rate was reasonable.

With these new powers, the ICC gained almost complete control over rail rates,

The railroad industry continued in decline from that point on Peak in mileage in 1916 254,000 miles 1975 – 199,000 miles ICC – Replaced by Surface Transportation Board in 1995 2004 – 140,000 miles 96,000 by class I RRs

Regulatory Policy – aimed at causing zero economic profit

AC

MC

MRTransfer to consumers

Dead Weight loss

Monopolist price

Since AC = P there is a natural urge on the part of producers to inflate costs

Predatory pricing For a decreasing average cost industry,

there is an incentive, in the presents of competition to reduce cost below long run marginal cost to variable costs.

This creates market instability. So long as a producer is providing services

between marginal and average costs they are not preditory pricing.

Example of fair price discrimination

D1

D1

D2

AC

AC

MC

MC

Q1 Q2 Q3

P1

P3

P2

A

CB

Price discrimination

Both shippers can not be served at their marginal cost otherwise the railroad would operate at a deficit.

If we discriminate and sell D1 at average cost and D2 at P2 then the total sales are qual to Q1+(Q3-Q1). The Railroad still covers its average price and by virtue o the two pat pricingt it produces a more efficient level of output; P3 as opposed to P1. The net benefits is ABC.

Who deserves the marginal cost price?

Price discrimination example

18.501,1$

)1000(

000,1

000,1

000,000,1Z

FAC

cost. average itsat units 1,000 ship to willingisfirst The

market.our in shippers twoare e that therSuppose

9.0

000,1$

000,000,1$

9.01

1

AC

Z

K

K

F

KZFTC

Numerical example

costs marginal covers $390 ,

09.362)80001000(

)1000(9.0

Z

KMC

unit.per $390at service price unfair to beit Wouldunit.per $400 of price aat

businesss hisfor competingcompany on ansportatianother tr hasbut

units 8,000 additionalan ship to willingisshipper secondA

-1

Therefore

914,620,4$

00)$1,000(9,0 $1,000,000 costs Total

$4,621,180

(8,000) 390 1,000)$1,501.18( Revenue Total

9.0

Price Discrimination by Railroads

The demand for freight transportation is typically very inelastic. This is intuitively seen when considering that transportation only accounts for 2% of the final price of goods on the averrage. For bulky commodities with few transportation alternatives, transportation accounts for an even greater share.

•Ferrous Mining 9.1%•Chemical and fertilizer mineral mining 6.4%•Lumber and wood 5.1%• Stone and clay 6.0%•Iron and steel products 5.3%

What lead to deregulation The collapse of the railroad industry in the 1970s

Bankruptcy of the New York and Pennsylvania Central Railroads in 1970

Bankruptcy of the Milwaukee Road (1975) and the Rock Island Railroads (1977)

Loss of rail passenger services by 1970s and organization of AMTRAK

Pre-deregulation reforms Liberalization of truck and rail rates in the mid-1970s

Regional Rail Reorganization Act (1973) Created Conrail

Railroad Revitalization and Regulatory Reform Act (1976) Allow railroads to set rates in markets where they were dominant Deregulated produce Create funding for capital improvements

U.S. Deregulation 1978 Airline deregulation act

Deregulated entry, exit, and pricing by 1983 1980 Motor carrier reform act

Deregulated entry, exit, and pricing and permit private contract negotiation

Did not deregulate intrastate trucking 1980 Staggers rail act

Permitted private contract negtiation Total deregulation occurred slowly.

Airline Industry 1978 Disbanding of the Civil Aviation Board (Airline

Deregulation Act) Impacts

Pricing flexibility Hub and spoke system for large carriers

More likely to keep passengers on carrier New carriers – new carriers and entrants Increased competition Discount carriers

Southwest, America West, ATA, JetBlue, AirTran, Spirit and Frontier.

Regional Carriers American Eagle, ExpressJet Airlines, Comair, SkyWest

Airlines, Atlantic Southeast Airlines, Atlantic Coast Airlines, Mesaba Airlines, Horizon Airlines, Mesa Ailines, Air Wisconsin, Piedmont Airlines

Regional Airline Growth

Taken from the Regional Airline Association Annual Report, 2003

Change of industry

Industry Issues 2000 slow down in the economy Declining fares (9/11) increased security Increased competition from low-fare

carriers Low fare carriers accounted for 7% of the market

in 1991 Low fare carriers accounted for 20% of the

market in 2002 Reduced willingness of customers to pay for

amenities

The Staggers Act Background

Conrail was highly unprofitable Milwaukee and Rock Island bankrupt Overall industry rate of return was 1% in 1978

(cost of capital 10.6%) Significant overcapacity Lightly-utilized branch lines in poor condition Stagnant traffic and declining market share Rate regulation seen as key impediment to

profitability

Rail Deregulation

Reduction in size of the industry Large Carrier concentration

1980 39 class I railroads (rr with more than $¼ Billion in gross revenue)

2001 8 class I railroads Only 4 US transcontinential railroads

Expansion of small and niche carriers due to labor regulation

Railroad Impacts Majority of freight is moved under

contracts Many joint rates are eliminated The operation of third parties (largely

steam ship lines) on Transcontinental lines.

Between 1980 and 1995 class 1 railroads shead about 32,000 miles in lines

ICC Termination Act of 1995 Mergers approved

UP-C&NW (1995, by ICC) BN-Santa Fe (1995, by

ICC) UP-SP (1996) Conrail split-up (CSX and

NS) (1999) CN Expansion

IC (1999) WC (2001) GLT (2004)

KCS-TFM (1996-2004)

Technological innovation

Unit train Philosophy Containerization – Double Stack Consolidation of terminals Automated train control system Positive train control systems Concentration of intermodel facility in

most dense markets

What happened since deregulation of Railroads

ICC Termination Act of 1995 Mergers approved

UP-C&NW (1995, by ICC) BN-Santa Fe (1995, by ICC) UP-SP (1996) Conrail split-up (CSX and NS) (1999) CN Expansion

IC (1999) WC (2001) GLT (2004)

KCS-TFM (1996-2004)

Trucking Industry Deregulation

Tail of two industries Less than truckload

Concentration, before 1980 494 Class I (over 5 million) carriers and by 1989 154

Rates have continued to decline at real levels of 2 percent per year

Truck Load industry Greater flexibility Many more entrant – O-O have become TL

carriers.