Regional Implications of Marginal Cost Rate Making

Abstract

It is generally accepted that the allocation of resources which will yield the maximum return in economic goods and services can be secured only when all prices are made to equal marginal costs. This definition of the optimum applies not only to industries which are normally competitive, or can be made so by antimonopoly action on the part of government, but equally to those industries the structural characteristics of which serve to make them natural monopolies, i.e., subject to long-run decreasing average total costs over a significant range of output. In the case of such decreasing cost industries, it has been shown that the optimum allocation of resources is secured by the use of the marginal cost or principle even if subsidization is found to be necessary to enable an operating unit to cover the full costs of production. This paper is not intended to elaborate or to discuss either the theoretical validity or the practical applicability of this principle. Rather it represents an attempt to predict or to project the possible results of the application of the marginal cost principle in one aspect of the railroad rate making problem. The particular aspect to be considered is that concerning the geographic or regional pattern of freight rates. It is assumed that the national government takes over control of the railroad system of the country and begins operations in accordance with the Lerner rule,' pricing services at the point where the marginal costs of providing the services in question are covered.2 It is accepted that marginal cost pricing or, in this case rate making, will not lead to the establishment of a uniform rate structure,3 simply due to the fact that the marginal costs of providing service will differ with the types of user, quantities taken, and with various geographic areas of provision. The possible differences in rates due to types of users, or to users of different quantities of the same service are not considered here. This discussion is limited to the possible differences in rates which may be charged to similar users of the same quantity of service who utilize the service in different geographic areas. It seems certain that even with the adoption of such a rule as the appropriate basis for rate making, rates will be set uniformly over rather broad contiguous