- Unconcerned about R&D.
As one of the Crown companies who enjoy governmental allowance, even if Railway China doesn’t practice any systematic reform, or make any effort on lowering its cost, it won’t suffer from any noticeable loss. In another word, it lacks of the motivation as well as pressure for exercising lowering its cost in order to create efficiency. Unless the below listed situation emerges, there would be no major change for Railway China’s policy:
- Competition from its substitute, such as highway and airway transportation, force Railway China to react with more active and economically healthy strategies;
- What Railway China is doing damages the majority interest of China, shrinking the cake of collective well-being so much that it negatively impacts the Chinese economic growth. Then, outside pressure necessitates its reform or innovation.
However, the characteristic of the population of China (large population), combined with the fact that the highway and airway networks are less developed, makes railway transportation relatively the cheapest and the most feasible method, so the above described situation and the kick for Railway China to practice any reform (managerial and technological) become less likely to happen.
- Artificially price aggrandizing to confine amount of service rendered.
In natural monopoly, the technical characteristic of degressive cost eliminates fully competition. For Railway China, its marginal cost is degressive, while its marginal cost is below its average cost. Therefore, when its price equals to its marginal cost, this price will be lower than its average cost, a situation that’ll make its profit negative and make it incur a loss. Shown as the graph, Pricing in Nature Monopoly.
As shown in this graph, the shaded part is the loss. Obviously, Railway China wouldn’t produce at the point where price equals it marginal cost. What it applies is the principle of marginal cost equals marginal revenue, and produce Q2 with the price of P2. This action, however, has already become damnous for collective well-being. As shown in the graph, since Q1 is the social efficient production, with the production of Q2, the total value for Railway China to rendered its service to its consumers is bigger than the its marginal cost, thus to increase the amount of service will increase total surplus.
Theoretically speaking, in order to decrease the total loss of collective well-being due to natural
monopoly like this, government should practice price regulation, according to its Marginal cost pricing or Average cost pricing principle and then, if necessary, give Railway China appropriate subsidy.
However, the regulated price is made based on historical data of the cost provided by Railway China itself. Obviously, this price-setting method gives competition-free Railway China great opportunity to add either all its high cost, mainly from its low efficiency, or the artificially exaggerated part of cost (in order to obtain monopoly rent) into the price of train ticket. Consequently, such bidding up lead to the price of train tickets largely exceeding the normal cost. On the one hand, this unavoidably creates production inefficiency and resource misallocation. On the other hand, if government wants to lower price by offering subsidy in order to avoid economical convulsions, as it did all these years, it has to do so by taxation. Obviously, the increase in tax will increase other economic cost and lead to further shrinking of total well-being.
Simply put, even before Chinese New Year price rise, the monopolistic and competition-free position of Railway China has put its consumers at a disadvantageous situation and caused huge deadweight loss.
Railway China: analysis on price rise
The supervisor of an industry, Railway China uses its monopolistic advantage to raise the price of train ticket. Nevertheless, this is not handled according to market rules and couldn’t be further from a market behavior. Ideally, if the capacity of carriage is below demand, price rise should give no just cause to criticism. However, a price that only increases never decreases is unendurable. Meanwhile, the legality of price rise during Chinese New Year is fishy. Since this is price rise of public service, it is necessary to hold a hearing of witness to solicit different opinions from consumers and operators in order to argue its necessity and feasibility. Furthermore, if, by any chance, the price rise is manipulated in light of the market rules, then after Chinese New Year’s Day, when everybody stays home and there is few to take the train, Railway China should depreciate its ticket price. Nonetheless, this is never the case.
Analyzing from the relationship of monopolistic marginal revenue and monopolistic marginal cost, as shown in the graph, The Cause of Formation for Price Discrimination.
Suppose the Demand Curve AB is linear, AC is the marginal revenue curve, this graph draws us a monopolistic industry, aka, Railway China.
If we take P for price and Ed for price elasticity of demand:
Since Ed=BM/MA=OP/PA, and ∆APD≈∆MFD →AP=MF → Ed=OP/PA=OP/(OP-FQ). → OP=P, FQ=MR
→ Ed=OP/(OP-FQ) → MR=P*(1-1/Ed)
Assume a given market (with a given MR) consisted of K1 and K2, which have different Ed, and then we have:
K1: MR1=P1*(1-1/Ed1) K2: MR2=P2*(1-1/Ed2) and MR1=MR2
When Ed1<Ed2, → (-1/Ed1) < (-1/Ed2)
→1-1/Ed1<1-1/Ed2. → P1>P2
In another word, when Ed differs, Railway China, without any improvement of its performance, can easily ask for a higher price to a less elastic market (K1) and increase its monopolistic revenue with this discrimination price. In Chinese New Year period, when huge population floods to all transportation centers, the utility in homecoming for reunion is skyrocketing, thus, the price elasticity of demand of this floating population is very low, or even we can say it’s rigid and with huge demand.
Before price rise, Railway China has already increased its producer surplus by its monopolistic price. Suppose MC is constant, then ◇NBCM is the lost consumer surplus, △MAN is the deadweight loss.
During Chinese New Year, student passengers, labor passengers and other tourism passengers entwine with each other and consist of a continuant passenger flood with low elasticity of demand. Railway China, therefore, applies price discrimination to transfer its high cost caused by its low efficiency to the passengers by the price rise and, thus, put the latter on an even more disadvantageous situation.
Hence, the graph of Inefficiency in Monopoly changes as follow. Using J as the axes, demand curve D1 shifts outward and becomes steeper to intersect with the axis of price at point E, and thus forms D2. We also can draw the marginal revenue curve before the price rise MR1 and after the price rise MR2. We, then, assume that MC, compared to D, is constant. Therefore, facing us is the K1 market situation described above: Railway China raises its unfair price again from P1 to P2, and thus shifts D1 to D2 as shown in the graph, Monopolistic Profit and Well-being shrinkage after Price Rise.
Because of the low elasticity of demand, the price rise earns Railway China huge easy money. Consumer loss increased by ◇ABCD+ △BCJ, with △BCJ being the deadweight loss. The consumer loss of ◇ABCD doesn’t consist of total loss of collective well-being, because it’s just income transfer. However, it fosters the desire of Railway China for squeezing excess profit by keeping its low-efficiency status quo, which is detrimental to the economic growth of China.
Furthermore, monopoly like this creates resource using inefficiency as well as inequality of income distribution. Namely, the income Railway China earns through price rise during Chinese New Year can hardly be translated into productivity that benefits the society as a whole.
From the point of view of the passengers, they have no control over this higher price (because of the homecoming enhanced low elasticity). From the point of view of society, the unjustified price rise of Railway China may seemingly look like a market-driven behavior. However, not only can’t it solve any managerial problems inhering within Railway China, but also it causes deadweight loss for collective well-being. With such price rise, the filthy lucre collected makes the effort emphasizing the quality of service and management become less remunerative and, thus, inessential, under which circumstances, lacking of pressure and motivation becomes inevasible.
Recommendations:
For those natural monopolistic crown industries that specialize on public establishment or services, such as transportation, medical care and electricity, focus on the social benefits as well as economic interest should be well balanced and thoroughly considered. Oversimplified price rise can solve no radical problem but worsen the stability of society.
Therefore, following two recommendations are offered for reference:
- Implementing Franchise Bidding to encourage internal competitive mechanism.
Logically speaking, to put into practice price regulation and allowance to monopolistic industries and, thus, induce such industries to utilize marginal cost pricing can improve the efficiency in allocating resources. However, in China, because of the comprehensive existence of information asymmetry, in addition to the severe absence of motivating mechanism to increase efficiency, this method might not be as helpful to reach what’s called Pareto improvement.
Therefore, by implementing Franchise Bidding, government auctions the franchise of one or several districts among a given period to a number of inter-competing enterprises and, then, authorizes the franchise to whoever bids the lowest price.
Obviously, this bidding can help to avoid the potential malpractice in price regulation by establishing of a healthy motivating mechanism and, therefore, effectively and economically restrict the monopolization of Railway China. Accordingly, train ticket price will drop to the level of efficient average cost and Pareto improvement can be achieved in this win-win game.
This proposal has remarkable feasibility. First, bidding enterprises possess only the operatorship, so there’s no fuss for asset transfer; second, the franchise contracts contains fairly simple listed terms, including maintenance of railway facilities, pricing for the services rendered and the service standards the franchisees must meet, so that the governmental supervision and administration can be easily implemented with the asset value intact or even reasonably appreciated.
- Further developing the highway and airway transportation systems.
Government should put more effort on energetically developing alternative transportation systems, such as highway and airway, by lowering their costs, to distribute passengers. Doing so not only would ease the flux of passengers in each transportation center, but also would give the whole industry healthy pressure for its efficiency improvement.
Conclusion
The price rise during Chinese New Year helps Railway China nothing in distributing the passengers, instead, it, again, grabs for its designer even more excess profit for covering the high cost due to the inefficient management and operation. Once again, this ”happy” ending defuses the driving force for any innovation and reform, shrinks the collective well-being and, furthermore, hinders the high growth of China’s economy.
The above analysis is established in studying the natural monopolistic position of Railway China, about its short run consequence only. By denying what Railway China has been unfairly practicing all these years, I offer recommendations and feasible solutions in order to beget more sophisticated and penetrating considerations.
