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Fair rates and rates of return in a deregulated rail industry

FAIR RATES AND RATES OF RETURN IN A DEREGULATED RAIL INDUSTRY This paper addresses the question of whether "fair" rates to captive shippers are compatible with "fair" rates of return for the railroads in the period of quasi deregulation since the passage of the Staggers Act in 1980. This question is analyzed by developing a simple model of "polar" Ramsey pricing in which a public utility faces a breakeven constraint while selling in two sectors: a competitive one in which price equals marginal cost; and a captive one, which has to bear the entire revenue burden. Under these circumstances, the markup in the captive sector can be shown to depend on the degree of economies of scale and the marginal -cost revenue shares in the captive and competitive sectors. Using the results of a translog cost function based on panel data of Class I railroads through 1974 1986, the paper shows that returns to scale are sufficiently large to cause coal rates to rise to socially unacceptable levels if captive coal shippers have to bear the entire revenue burden. Since, however, railroads currently earn a substantial markup over marginal costs on manufactured goods, the two goals should be compatible for most railroads under prevailing competitive relationships between the rail and the trucking industry. FAIR RATES AND RATES OF RETURN IN A DEREGULATED RAIL INDUSTRY Ann F. Friedlaender