Throughout 1906, 1907 and into 1908, many states and cities passed price ceilings on train travel. However, while the marginal cost of an additional passenger on a railroad car is likely close to zero, much like the marginal cost of an additional passenger on an airplane is close to zero, the average variable cost of an additional passenger is not zero. This is important because policy makers (and the public at large) seem to believe that if marginal cost is zero then price should be close to zero and somehow the firm will still make a positive profit.

However, while price equals marginal cost in perfectly competitive (or perfectly elastic demand) markets, in markets with downward sloping demand curves, price and marginal cost are rarely equal to each other. Indeed, if a firm finds that price is less than average variable cost, they might temporarily shut down in the short-term. Consider baseball teams that shutdown during the winter months, not because no single person would attend a baseball game in January but because there are not enough people willing to attend such that price is greater than or equal to average variable cost.

Further, a firm will permanently shut-down or move out of a market (whether geographic or product) if they think demand will not recover so that price will eventually exceed average variable cost. In the case of legislated price ceilings, price cannot respond to demand changes and therefore price might not exceed average variable cost.

This situation is succinctly reported in the Jan. 17, 1908 NYT:

Announcement was made to-day by the Michigan Central Railroad Company that on Jan. 19 seven passenger trains on four divisions of the road will be discontinued. While the Michigan Central always makes a Winter readjustment to its passenger train schedule and discontinues some service, it is state that the falling off of receipts under the two-cents fare law is responsible for the order being more sweeping and wider than is generally the case.

As a big fan of Atlas Shrugged I find this story interesting because the Michigan Central did the unthinkable, at least from the point of view of the legislature: they chose not to run trains. The loss of revenue to the Michigan Central and consumer surplus of those who would have ridden the seven trains would seem to be pure dead-weight loss due to the intervention.

How long until the Michigan Central was accused of a) discriminating against certain consumers; b) putting profits over people; c) violating some law requiring them to run trains at a loss; d) all of the above?

I will keep an eye open for more on this story.