Economic Analysis of Regulated Markets by Jorg Finsinger

By Jorg Finsinger

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And all the statistical evidence confirms that managerial prestige and compensation are influenced most heavily by two variables: the firm's profits, and size. Both these influences, then, clearly put pressure on management to leave no stone unturned in seeking to increase company profits and to gain full access to the capital market. There is at least one more reason why the managements of railroads with inadequate revenues will be forced to maximize profits. Once deregulation has occurred, railroads which fail to take full advantage of their profit opportunities will leave themselves open to attempted takeovers.

20 After all, if some services were priced excessively high, the excess revenues would have to go somewhere, either producing excessive overall earnings for the carrier or cross-subsidy for some of its other services. Thus, there is a logical indirect way to carry out the stand-alone cost test: no rate or group of rates can exceed stand-alone costs if overall earnings are not excessive and if all groups of rates are compensatory. The indirect test for a carrier whose total revenues are less than total costs is somewhat less stringent: The revenues from a group of services lie below stand-alone costs if any deficit between the remaining services' revenues and incremental costs is less than the carrier's overall deficit, that is, the difference between its total revenues and total costs.

The necessary elements of such a demonstration are assessments of the elasticities of demand and marginal costs of the carrier's services, other than those sufficiently competitive for their prices to be determined entirely by the market. Of course the rail carriers have much experience in assessing variable costs, and these can provide the basis for workable approximations to marginal costs if the principles outlined in that part of the preceding section concerned with the definition of marginal cost are followed.

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