Question

Changing market conditions may allow trucking firms to make economic profits in the short run, but not in the long run. Freight rates are always forced back to the point of productive and allocative efficiency. The case is different for the railways. They can make economic profits on a continuous basis, and are neither productively efficient, nor allocatively efficient.

20%       a)    With an appropriate model(s) to explain why economic profits in trucking are temporary, while the railways can earn economic profits consistently.

20%       b)    Explain why the economic profits made by the railways may not be so bad, depending on their use of these funds. And with an appropriate model, why the deadweight loss in social welfare is the real problem.

Answer 1

Trucking firms are perfectly competitive firms. There are large number of sellers and buyers in perfect competitive markets. Freight rates are determined market demand and market supply curve in competitive market. There freight rates are taken by competitive firms. Trucking firms can easily enter and exist the competitive market. That is why economic profits are temporary in trucking market, In short run if a firm earns economic profit ( average revenue is greater than average costs). Then other firms outside the market attracts the economic profits nd they easily enter the market. When new firms enter in the market ,market share of all existing firms will reduce and they would earn only normal profit ( zero economic profit). But railway is a monopoly ,under monopoly market ,Entry is blocked. No new firms will enter the monopoly market. So it always earn economic profit in long run. b. Railway is monopoly market , which always try to maximise its profit by restricting supply output and increasing prices. It always fixes the price which is the greater than the marginal cost of railways. It will never produce an output with elasticity less than one. Deadweight loss in social welfare is the real problem. Because deadweight loss reduces the both producer surplus and consumer surplus when the economy produces at inefficient quantity. Deadweight loss occurs due to underutilization of resources . Monopolist produces less than optimum level of output