outcome of this deregulation? Attracted by excess profits, new taxis would enter the
market. If fare regulations remained unchanged (P $10), the influx of taxis would
mean fewer trips per taxi and zero economic profits for all taxis in equilibrium.
Alternatively, the commission could set lower fares (say, P $9.50) in conjunction with
free entry, allowing price to decline with the influx of supply. A third option is to allow
free entry and, at the same time, deregulate fares. In the past, a number of cities (e.g., San
Diego and Seattle) have tried to introduce free competition into taxi markets. Drivers are
free to discount fares below the standard meter rates (with these discounts being posted
on the cabs’ doors). Supply (augmented by free entry) and demand would then deter-
mine prevailing taxi fares—presumably at levels well below those set by regulation.
Finally, our economic analysis provides a ready explanation for the reluctance of
commissions in major cities like New York to increase the number of medallions. A large
increase in medallions would reduce the profit associated with holding a medallion and,
therefore, decrease the value of the medallion itself. (Allowing perfectly free entry would
eliminate these profits altogether and reduce the value of a medallion to zero.) Fierce lob-
bying by taxi drivers and taxi companies has persuaded city governments to retain the
current medallion system.SUMMARY
Decision-Making Principles
- Whatever the market environment, the firm maximizes profit by establishing
a level of output such that marginal revenue equals marginal cost. - A monopolist sets MR MC, where MR is determined by the industry
demand curve. The magnitude of monopoly profit depends on demand
(the size and elasticity of market demand) and on the monopolist’s
average cost. - In monopolistic competition, the firm’s long-run equilibrium is
described by the conditions MR MC and P AC.
Nuts and Bolts
- Under pure monopoly, a single producer is shielded from market
entrants by some form of barrier to entry. To maximize profit, the
monopolist restricts output (relative to the competitive outcome) and
raises price above the competitive level. - A cartel is a group of producers that enter into a collusive agreement
aimed at controlling price and output in a market. The cartel restricts
output and raises price to maximize the total profits of its members. The
incentive for individual members to sell extra output (at discounted
prices) is the main source of cartel instability.
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