Academic journal article The American Journal of Economics and Sociology

Regulation and Rate-Making. (Chapter 7)

Academic journal article The American Journal of Economics and Sociology

Regulation and Rate-Making. (Chapter 7)

Article excerpt

Introduction

AN EARLY AREA OF SPECIALIZATION IN ECONOMICS dealt with theoretical and practical questions on the regulation of transportation and public utility concerns. The Munn vs. Illinois decision of the Supreme Court and the Interstate Commerce Act of 1887 moved the railroad industry toward a regulated status, and the 1906 amendment to the act gave the Interstate Commerce Commission the authority to set maximum rates. Along with legislative and judicial bodies and state and federal commissions, economists took an active interest in the attempt to regulate railroads in the public interest. That the "public interest" could be furthered by regulation was an assumption shared by all of these parties as well as, perhaps, the managers of the railroads. (1)

Harry Gunnison Brown's first published article (2) and his doctoral dissertation (3) were concerned with questions related to railroads and rate-making. His interest may have been sparked by the economic implications of recent judicial decisions and legislative acts. Also, Arthur T. Hadley, then president of Yale University and friend of Irving Fisher, was an authority on railroad economics and maintained an interest in this field. (4)

Brown's 1916 Transportation Rates and Their Regulation, published by Macmillan, endeavored to present a complete theory on the subject. (5) In the preface, Brown cited John Bauer for a thorough reading and criticism of the text. Brown's 1925 article, "Railroad Valuation and Rate Regulation," featured a defense of reproduction cost as a basis for the valuation to be used in rate-making. (6) This article sparked a long-running debate with John Bauer and James C. Bonbright, among others. Alfred E. Kahn in 1970 said this article contained the classic argument against the original cost valuation method in rate-making. (7) Brown's subsequent articles and exchanges centered on this and related questions.

Early Articles

IN HIS 1907 PAPER, Brown attempted to reconcile two views on how railroad rates should be made. One view was that railroad traffic should be charged "what the traffic will bear," which would admit discriminatory charges. The other view was that charges should correspond strictly to costs. He assumed that the railroads, whether competing or noncompeting, were subject to "increasing returns," (8) due primarily to the relatively high overhead costs with largely constant operating costs. He noted that in these conditions additional freight should be desired as long as it pays at least the "special additional cost" incurred. Brown regarded the question of whether the extra freight also should pay its portion of the fixed expenses as an open one. He appeared to take "marginal cost" pricing as a first principle and regarded the distribution of the fixed costs as dependent on the competitive conditions.

He then considered the relative rates charged by competing railroads and noncompeting railroads in terms of discrimination among places, commodities and corporations. He found in general that competing railroads, relative to noncompeting ones, would tend to discriminate in favor of some cities, larger corporations and certain commodities. The competing railroads would alter prices to attract business from competitors while the monopoly railroad would reduce rates only to attract new customers. Competition would force a reliance on cost of service as opposed to value of service and would tend to distribute the fixed costs in production to direct costs incurred. He concluded that discriminatory reductions in rates were socially desirable as long as they resulted in increased traffic and not simply the diversion of traffic.

In this article and another published in the next year on the similarities of monopolistic and competitive price-making, (9) Brown clearly was not thinking of the competing railroads as competitive in the usual sense of "perfect competition. …

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