Essentials of Economic Theory Part 19

_Unequal Compet.i.tion Typical of Carriers._--Our recent ill.u.s.tration represents a similar condition in carrying. The public gets a slight gain from the advent of a sailing vessel; but it fails to get the further benefit that the advent of a second vessel will ultimately bring. For a time the freight charge stands nearly at what teamsters have charged. For cheaper rates the public must wait for the advent of another vessel.

_The Cause of the Partial Monopoly in Carrying._--There is nothing to prevent a second schooner from being put on this route, if the returns to be expected should warrant it. At the outset the new vessel would get only about a half of the amount of traffic enjoyed by the first, and the rates would probably be reduced by the compet.i.tion between the two. Until the returns of the first vessel become large it has no rivalry to fear, but it is clear that its monopoly is held by a very precarious tenure. It is not likely long to enjoy the benefit of any charges which yield much profit. The growth of traffic will in due time bring the competing vessel, and the rule of returns that only cover costs will again a.s.sert itself. The owner of the first sailing craft has been able for a time to charge "the value of the service" he has rendered, as that value was determined independently of his own action; but now this value itself depends on his action and that of rival carriers using the same route, and it adjusts itself at the level of cost.

_The Effect of partly Unused Vessels for Carrying._--The case ill.u.s.trates another principle which is equally general. The _entrepreneur_ whose capacity for producing is only partially utilized may often take some orders at less than it costs to fill them, as cost is usually understood, and he will still be the gainer. In manufacturing as well as in carrying there are "fixed charges"; there are costs which stand at a definite amount which is independent of the volume of traffic, while other costs increase as the volume grows.

These are the "variable costs," and they have to be further cla.s.sified, since some of them do not increase as rapidly as the business grows, while others increase with the same rapidity as does the business. The makers of sewing machines, typewriters, reapers, and mowers, and indeed machinery generally, can usually increase their product without correspondingly increasing their outlay. They can make goods and sell them in a foreign market at rates which would injure and might even ruin them if they were applied to the sales made in their own country. This fact is most obvious when the manufacturer's machinery is not all kept running or when it all runs only a part of the time. Increasing the output is then a particularly cheap operation. When a carrier's facilities are partially unused--when a s.h.i.+p carries a cargo in one direction and returns in ballast, or when it sails on both trips with its hold only half full--it is ready to carry additional goods at a low rate provided that this policy will not demoralize its existing business. In our ill.u.s.tration we have a.s.sumed that some merchandise is made at A and consumed at B, but it may well be that goods of some sort are produced at B and consumed at A. There may be stone quarries at B and there may be need of stone for paving or building at A, and the vessel may carry a return cargo of this kind at any rate which does not greatly exceed the mere cost of loading and unloading it and be better off for so doing. If the entire difference between the cost of the stone at B and the cost of producing it at A from some other source is a very slight one, the amount of it still represents all that the s.h.i.+p can get for carrying the stone. The utmost that the traffic will bear is this difference in costs; and yet the business will be accepted, for the return exceeds the merely variable costs which it entails. The fixed charges, the interest on the cost of the vessel, and the outlay for maintaining it do not need to be paid in any part from the returns of this extra business. They are already provided for.

If instead of returning from B with a hold quite empty, the vessel made both voyages with a hold only half full, the result would be similar. It would then be in a position to make a low bid for further freight in both directions. If this entails no cutting of the rates for carrying the original goods, the vessel can take further goods with advantage at any rate above the merely variable costs.

_Production which is Advantageous though it does not repay all Costs._--There are two general conditions under which it is advantageous, both in making goods and in carrying them, to extend production, though the further returns which are in this way gained do not cover all costs. First, the producer must have an unused capacity for making or carrying goods. In such a case it is possible to make or carry an _increment_ of goods without entailing on himself an increment of cost that is proportionate to the amount carried. In his bookkeeping his original business is charged with costs amounting to a certain sum per unit of goods produced or carried. His further business is charged with a smaller outlay per unit.

Secondly, it must be possible to demand separate and independent returns for the different increments of goods, so that cutting the rate charged for one part of the traffic does not entail cutting the rate charged for the other. In the case of a manufacturer this is secured, either by carrying some goods to a remote and entirely independent market, or by producing some new kind of goods the low price of which will have no effect on the sales or the prices of the other kinds. In the case of the carrier it is accomplished in a variety of similar ways. He can take return cargoes at a low rate. If he stops at different ports along his route he can charge less for goods landed at certain ports than for those landed at others. He can cla.s.sify his freight and carry some of it at a rate at which he could not afford to carry the whole. With the growth of traffic, however, this condition tends to disappear. Its existence requires that the carrier should have facilities only partially used. As the s.h.i.+p acquires fuller and fuller cargoes, it ceases to be advantageous to fill the hold with goods which pay lower rates than others; just as a mill, which may have run for a time partly on goods that yield a large return and partly on those which yield a small one, gradually discards the making of the cheaper goods as the demand for the dearer kind increases. The vessel which can get full cargoes of profitable merchandise will cease to devote any s.p.a.ce to what is less profitable.

In the end the s.h.i.+p in our ill.u.s.tration will be transporting in both directions all the first-cla.s.s freight it can take, and will accept neither the stone nor the merchandise consigned to ports to which it can be carried only at the cheap rates.

_Result of Effective Compet.i.tion throughout the Carrier's Route._--The condition just described--that of full cargoes of profitable goods--inevitably attracts a rival vessel, and the ordinary effects of compet.i.tion then begin to show themselves. The vessels pursue the same route, cater to the same traffic, and if they try to get business from each other, bring down their charges. The warfare may even bring them to reduce the rates to the level at which only variable costs are covered--a policy that, if persisted in, would bankrupt them both; and here, as well as in the case of railroads, there is a powerful motive for combining and ending the war. It usually causes a merely tacit agreement to "live and let live"--a concurrent refraining from the fatal extreme of compet.i.tion. The reductions, as made, have to be general and to apply to all parts of the traffic, and unless each part of the freight carried earns a _pro rata_ share of the fixed charges incurred in the business, the traffic is carried at a loss. On the supposition which we have made--that the special and comparatively unprofitable increment of carrying was discontinued as soon as the first vessel could use its entire cargo s.p.a.ce in transporting goods of a high cla.s.s--the arrival of the second vessel may cause the less profitable carrying to be resumed, since there will not be enough of the better sort to afford two full cargoes. Moreover, a normal kind of compet.i.tion will stop short of the warfare which drives both rivals into bankruptcy, and will leave the rates at a level at which the receipts of each carrier cover all his outlays.[2]

[2] A full discussion of the limits of freight charges would take account of the fact that "what the traffic will bear" is an elastic amount. An infant industry will bear less than a mature one; and moreover, a rate that it will bear without being taxed out of existence may be sufficient to stunt its growth. A railroad may be interested in hastening its growth.

When goods have one cost at A and another at B, a railroad company may carry them from the one point to the other for less than the difference between the costs because it wishes the industry at A to grow and furnish freight. Farmers who are introducing a new crop in a section of country remote from a market may be encouraged by a rate for carrying which leaves them a margin of profit. It is when a branch of production has more nearly reached its natural dimensions that the charge for carrying its product tends to approach its highest limit.

CHAPTER XXIV

THE FOREGOING PRINCIPLES APPLIED TO THE RAILROAD PROBLEM

_Simple Cases of Charging "What the Traffic will Bear."_--The value of a study of primitive carriers and their policy lies in the fact that it ill.u.s.trates principles which apply to transportation by a complicated system of railroads, although in this latter case they are not easily discerned. Imperfect compet.i.tion is what exists in the department of carrying. So long as a railroad is without any rival it may, in some cases, charge for moving goods from one point to another about as much as the cost of making them at the latter point exceeds the cost at the former. This is the simplest case of charging what the traffic will bear. Or, again, the situation may be dominated by producers at a third point who can make goods and get them carried to the place we may term the market for less than the cost of making them directly in this latter place. In such a case the road may demand nearly the amount by which the cost of making the goods at an accessible third point and moving them to the one which is their market exceeds the cost of making them in the place first named; and this is a slightly less simple case of charging what the traffic will bear. It is appropriating the difference between two natural values neither of which the railroad itself fixes.

_Charges based on Various Kinds of Cost._--The charges of the railroad may be limited by the compet.i.tion of inferior carriers who use its own route, such as teamsters whose wagons use a public highway running parallel to its own track. Here charges are based on costs, but not on those which the railroad incurs. They are the costs which the teamsters incur; and if the railroad has much business, its own costs are less and it makes a profit. The charges may be based on costs incurred by more economical carriers, like owners of s.h.i.+ps, and in such a case the rate which the railroad can get may be less than its own costs, if these are figured in the simple way of dividing a total outlay by a total number of units of freight transported. The rate is based on the s.h.i.+powners' costs, and these are so low as to bankrupt the railroad if it should reduce all its charges to such a level. It reduces them thus only on the particular route where compet.i.tion by water is encountered, and keeps them elsewhere at the higher level. In the case of s.h.i.+pments by rail over such routes "what the traffic will bear" is determined by the low charges established by the s.h.i.+ps; and this means that it is determined by a certain definite cost of carrying goods between the very points which the railroad connects.

_The Exceptional Importance of Fixed Charges in the Case of Railroads._--The railroad, in the case just noticed, carries its rates below costs, as these are computed in a simple way, but keeps the lowest of them somewhat above the variable costs which we have defined; and there appears the important fact that the fixed costs incurred by the railroad form an unprecedentedly large part of its total expenses. The interest on the outlay it makes for roadbed, track, bridges, tunnels, terminals, etc., is something for which there is no fair parallel in the case of wagons or s.h.i.+ps. This is the first unique fact concerning railroads and their policy; and the second is that they continue very long in that intermediate state which we have ill.u.s.trated by the s.h.i.+p which had only a partial cargo and was impelled to take some traffic at a special and low rate. For many years the railroad only partially utilizes its plant; and so long as that is the case its natural policy is one of drastic discrimination between different portions of its business. A third great point of difference between the railroad and other carriers appears if, while its capacity is still only partially utilized, it encounters the direct rivalry of other railroads that are eager for business; compet.i.tion then takes a shape which impels the partic.i.p.ants irresistibly into some kind of combination. The union may be tacit or formal, and it may depend on personal relations or on some merging of corporations; but toward something that will make the rival lines act concurrently and with mutual toleration the situation impels them with unique force.

The general features of railroad rates, then, are--

(1) Some charges based on the difference between the natural value of merchandise at the point of origin and its value at the point of delivery, as this latter value is determined by causes independent of the rates charged for transportation between the two points;

(2) The adjustment of other charges according to costs incurred by independent carriers operating between the same points;

(3) The exceptional importance of the railroad's "fixed costs" and the drastically discriminating rates to which this leads;

(4) The irresistible motive for combination where direct compet.i.tion appears between railroads connecting the same points.

We speak of the condition of railroads as an intermediate state because it is one out of which a natural development takes other carriers when their capacity for service is fully utilized. The same cause--a complete utilization of the plants--would have a like effect in the case of railroads; but the cause is so slow in coming into full operation that few persons think of it as affecting the problem at all. The problem of freight charges on railroads is usually regarded as if the intermediate state were destined to be perpetual. It is, however, entirely true that a full utilization of the plants of railroads would tend to take them out of this state. If the increase of business came after a combination had been effected, it would tend to put a stop to the sharp discriminations to which the eager quest for traffic has led. Different s.h.i.+ppers could more easily secure equally favorable treatment. Freight of a low grade would be less desired, since the s.p.a.ce it would require might otherwise be available for business of a more profitable kind, and the rates on such freight would rise. The increased traffic would make it possible to earn large dividends without increasing charges on the lower grades of freight, and while greatly reducing the charges on the higher grades; but no economic force would be available for securing this adjustment. The state, by positive regulation, might secure it and might bring the earnings and the charges of the railroads more or less nearly to the normal standards which prevail where compet.i.tion rules; but if compet.i.tion were here to begin, it would result quite otherwise. It would restore the old condition of partially utilized cars, track, etc., and cause a new strife for traffic, which would cause some freight to be taken at very low rates, but would lead to inevitable consolidation and higher charges.

In general industry compet.i.tion tends so to adjust prices as to yield interest on capital, wages for all varieties of labor, including labor of management, and nothing more, and this is the outcome elsewhere demanded by a growth of business coupled with a theoretically normal and perfect action of compet.i.tion; but the peculiarities of compet.i.tion between railways do not bring about the evolution which would give this result. Combination is effected long before the returns from the total traffic are made normal and before the returns from different parts of it are brought into their legitimate relation to each other. After the union of rival companies, railroads continue to be in that intermediate state in which the effect of an unused capacity for carrying has its natural effect in charges which discriminate widely between different localities and between different kinds of freight. The railroad traffic does, indeed, begin to follow the course which we have ill.u.s.trated in the case of transportation by water. It takes a few steps in that direction, but further progress is then stopped by combinations.

The fundamental laws of economics still apply. The static standard of freight charges exists, and one can form some idea of what actual charges would be if the forces which elsewhere tend to bring prices to their theoretical standards could here operate unhindered. The hindrances, however, are such as definitely to preclude such a result.

The rates do not become in a true sense normal. Even under such active compet.i.tion as at times exists they do not become so, while without compet.i.tion they never tend to become so. It would, however, be a gross mistake to a.s.sume that static standards have no application whatever to railway transportation. The whole subject is most easily understood when those standards are first defined and the baffling influences which prevent actual rates from conforming to them are then separately studied. There are influences which bring the various charges of railroads within a certain definable distance of normal standards.

[Ill.u.s.tration: C | . ABANDONED | ROUTE .

| RAILROAD v A------------------------------>B / / ____ / ___ __________/ ____/ WATER ROUTE ]

The situation of railroads we take as we find it--one of complete consolidation in case of many roads, and of harmonious action, or quasi-consolidation, in the case of others. In general their charges are fixed by the place value they create, as that value is established by influences other than the charges themselves. It might seem that the charge for carrying fixes the place value. Whatever a railroad demands for carrying goods from A to B measures the enhanced value which they get in the moving; but if they would have possessed at B the same value that they now have, even though the railroad had not existed at all, it is evident that it is this value minus the value of the goods at A which fixes the charges for carrying, rather than that these charges fix the place value. We have seen in very simple and general cases how this principle works, and have now very briefly to trace the working of it in the case of a system of railroads. The special method of reckoning costs to which we have referred is an important element in the process.

_"Costing" comparatively Simple in the Bookkeeping of Competing Producers._--In the study of ordinary industries we have encountered conditions which render the bookkeeping of a producer simple and cause him to charge all his costs, in a _pro rata_ fas.h.i.+on, to his entire product. If his goods and those of his rivals are of one kind and are sold in a single market, a cut in the price of any one portion of the product involves a corresponding cut on the entire output. It is not possible to single out any particular increment for a reduction of price and leave the rate unchanged on the remainder. Where products are of different kinds it is possible to make a cla.s.sification of them so as to get a large profit on some, a small one on others, and none at all on still others. When compet.i.tion has not done its full work, something of this kind happens in many departments of business. A condition of unequal gain from different portions of an output lingers long after some effects of compet.i.tion have been realized. In the end, however, it must yield if compet.i.tion itself does its complete work, and whenever we adhere heroically to the hypothesis of the static state, we preclude this inequality of charges. Rivals who contend with each other for profitable business bring the prices of the goods which afford the most gain to such a level that a mill which makes this type of goods will pay no more in proportion to its capital than one which makes other types. The total cost of production, fixed and variable alike, would at that time, as we have seen, be barely covered, and might correctly be apportioned in a _pro rata_ manner among all parts of the product.

_The Effect of Increasing Business on Comparative Charges._--Compet.i.tion of this perfect kind does not exist in manufacturing and is far from existing in the department of carrying, and it is important to know whether with growing business and greatly tempered rivalry there is any tendency toward the equalization of charges and the simplifying of the mode of reckoning costs. When a mill has more orders than it can fill, those it wishes to be rid of are the ones which yield the smallest profit. They enc.u.mber the mill and prevent the filling of more profitable orders; and the natural mode of reducing the amount of this undesirable part of the output is to raise the charges on it. This comes about without much aid from compet.i.tion, for when all producers find their capacity overtaxed, they have no motive for contending sharply for business. Underbidding has for its purpose attracting business from rivals and is an irrational operation when all have orders enough and to spare.

Compet.i.tion is largely in abeyance when the business any one can have is overabundant.

_These Principles Applicable to Carrying._--What we here a.s.sert concerning goods manufactured by independent mills would be true of goods carried by independent vessels, if they plied between the same two ports with no intermediate stops. If their capacity should at any time be overtaxed, they would not reduce the charges on higher grades, but they would raise them on the lower grades, and the cla.s.sification of freight would lose some of its significance. The lowering of the charges on the high grades of freight would come when the profits of the business should attract new carriers, who would naturally seek for the traffic that paid the best, till all kinds paid about alike. The mode of reckoning costs might then become simple--a _pro rata_ division of total outlays among all parts of the business.

_The Condition of Uniform Costing never realized upon Railroads._--Not a single one of the essential conditions of equalized charges and uniform costing is now realized upon railroads, and there is only one of them that is approximated. Separate markets for different parts of the traffic are provided by the nature of the business. Every point to which goods are conveyed furnishes such a distinct market, and the service of carrying goods to it is paid for by a distinct set of customers. It follows, therefore, that some rates can be cut without affecting others, and they regularly are so. The second condition, that of bringing the carrying capacity of railroads into the fullest possible use, is attainable, but it is very remote. At times there is a congestion of freight and, in general, the capacity of existing plants is more nearly used than it heretofore has been; but by an addition to the rolling stock they could carry more than they do and the additional traffic would cost far less than the portion already carried. Moreover, with no addition to the rolling stock, very considerable enlargements of traffic could at many points be made.

Thirdly, compet.i.tion between railroads is not at present effective enough to bring about a reduction of the higher charges and make returns and costs simple. Combination takes place long before the discriminating charges are abandoned. Low-grade freight continues to be carried side by side with the high-grade which pays better. Charges to terminal points continue to be low, while charges to intermediate points are high. In a sense one may say that a tendency to discontinue these practices exists, but it is a tendency that is so effectually resisted that its natural results are only in small part realized. If a dam is built across a reservoir, holding the waters on one side ten feet above those on the other, one may say that the waters have a tendency to reach a uniform level, since the power of gravity is exercised in that direction; but the dam baffles the tendency. And so in railroad operations something interferes which checks the force of compet.i.tion or removes it altogether, long before the discriminations in freight charges are removed or very much reduced.

_An Intermediate State made relatively Permanent._--As we have said, the condition of traffic on railroads is a.n.a.logous to what in the case of manufacturers and primitive carriers would be regarded as a transitional state soon to be left behind; but in the case of railroads it is relatively permanent. It is the condition in which certain natural economic forces are working vigorously, and, if they were not counteracted by other forces, would end by making natural adjustments and establis.h.i.+ng normal rates for the carrier as well as the manufacturer. In this intermediate state the natural forces are counteracted and the adjustments are never made, and what we have to study is the degree in which they are approximated.

[Ill.u.s.tration: C | | | HIGHWAY | | A--------------------------------B RAILROAD ]

_A Simple Case of Special Costing Applied to Certain Traffic._--We will suppose A and B are connected by a railroad, while C and B are connected by a highway over which transportation proceeds by the primitive means of horses and wagons. It is like one of the cases we have already stated, with the exception of the fact that the carrier over the longer route is a railroad. The limit of what the railroad can get is the natural difference between the cost of making the goods at A and the combined costs of making them at C and carrying them to B. This definitely limits the railroad charges. Whatever difference of cost there is the railroad can get if it chooses, and barring any deduction it may make in order to induce production at A and make traffic for itself, it will get it. The rate which is fixed for the railroad may be sufficient to cover the total costs chargeable to this portion of its traffic on the simple and _pro rata_ plan of costing, or on the other hand, it may cover only a portion of the fixed costs or no portion at all. This means that the standard which is set by the differing values of the goods at A and at B may or may not yield a profit to the railroad. If it is so slight as not to cover even the variable costs of carrying the goods, the railroad will not carry them, and the supply will be allowed to come from C rather than from A. If it covers more than these variable costs, the road will accept and carry the goods. If the traffic affords any appreciable margin above the variable costs, it will be the policy of the railroad to make its charges low enough to attract the traffic, and this will slightly reduce the place value of the goods at B and bring it below the cost of procuring them from C. The railroad will thus secure the whole traffic to the exclusion of that which came from C. If the costs of making the goods at A and C are alike, then the charge for carrying from A to B will be just enough below the total costs of carrying in wagons from C to B to stop the carrying over this shorter route and appropriate the whole business; but this charge may not cover total costs of carrying from A. It may yield only a slight margin above the variable costs attaching to this part of the railroad's business. It thus appears that this carrier can with advantage accept the freight at a rate that by a perfectly normal bookkeeping is below cost, while the teamsters on the road from C cannot do this.

[Ill.u.s.tration: C | | | RAILROAD | | A--------------------------------B RAILROAD ]

_A Second Case in which Carrying is done for Any Amount above Variable Cost._--Let us now suppose there is a railroad from C to B as well as one from A to B. There is now compet.i.tion between makers at A and carriers from A to B, on the one hand, and makers at C and carriers from C to B, on the other hand; and whichever of these quasi-partners.h.i.+ps delivers the goods at B at the cheaper rate gets the whole traffic. By the terms of our supposition the makers in both places are offering goods at cost, and any cutting of rates that is to be done must be done by the carriers. To reduce the prices of the goods at the mills in either locality would put some of them out of business. We will a.s.sume that there is no consolidation and no other means of concurrent action between the railroads, and that the whole traffic will thus go to the route over which the lower rates are made.

For simplicity we will still adhere to the supposition of equal costs for manufacturing and of unequal costs for carrying. As the charge for carrying goes down, one or the other of the railroads will reach the point where the variable costs of this traffic are barely covered, while on the other line they are more than covered. Where rivalry is not tempered in any way whatever, the charge made by competing roads falls to a level at which returns only cover the variable costs incurred by one of the compet.i.tors, though it may return somewhat more in the case of the other.

_How Fixed Costs are Met._--This implies, indeed, that the fixed charges of both roads must somehow be met by the returns from other traffic; and this supposition is in accordance with the facts. A freight war may temporarily carry rates to a level where some traffic does not cover variable costs and where total traffic falls short of covering total costs. Such a situation cannot long continue, and the natural adjustment, under active compet.i.tion, is one at which rates on the traffic for which the two lines are contending are just below the variable costs incurred by one line but above those incurred by the other. There is nothing to prevent the stronger railroad from thus reducing its rates, attracting to itself the whole of the traffic, and putting an end to the rivalry of the other line. This would mean bankruptcy for that line unless it had other sources of income.

_The Effects of Bankruptcy on Costs._--Bankruptcy means a scaling down of the fixed charges of the railroad to such a point that the total traffic can meet them; but it does not enable the company to reacquire business that will not yield enough to cover variable costs. Adhering to the supposition that there is no mutual understanding, no pool, and no other approach to consolidation between the rival lines, we may safely say that the general rule which elsewhere governs rates holds true here. Two roads actively competing for identically the same traffic tend to bring charges to a level at which the variable charges entailed by this traffic on the one route are not quite met and the traffic pa.s.ses to the other line.[1]

[1] If we wish to vary our supposition that the cost of making the goods at A and at C is the same, we have a modification of the case we have stated. If it is much cheaper to make them at A, the railroad that carries these goods from there to B may charge more for carrying than does the one that delivers the goods made at C. It is possible that the difference between the costs of making at the different points may tell decisively in favor of the longer route, and it may be the railroad from C to B that first reaches, in its charges, the level of variable costs and sees its traffic handed over to its rival.

[Ill.u.s.tration: C | | | RAILROAD | | RAILROAD | A-------------------------------B / / ____ / ___ __________/ ____/ WATER ROUTE ]

_A Principle governing Compet.i.tion between Railroads and Carriers by Sea._--In a third case there may be between A and B a railroad and a water route also, while between C and B there is a railroad only. On the supposition we have made,--that compet.i.tion between carriers by water has done its full work,--the charge for carrying anything by water from A to B must be sufficient to cover a _pro rata_ part of the total costs. That may be sufficient to cover the merely variable costs entailed on the railroad, or it may not. If it does not, the railroad will not take any portion of the business except what it may take by reason of the greater speed with which it can transport the goods. If, however, the total costs of carrying by water exceed by a tolerable margin the merely variable costs of carrying by land, the railroad will be able to take the traffic. If this traffic goes to the water route, the charge made by the railroad from C to B is adjusted by a simple rule. This railroad can get the natural difference between the cost of the goods at C and the cost of similar ones made at A and carried by water to B. If the railroad gets the traffic between A and B, and the water route is abandoned, the case becomes the same as that which we have already considered,--the transporting is done at a rate which prevents one of the lines from covering its merely variable costs and secures all the traffic for the other line. The carrying from A to B goes by land or by water according as the variable costs, in the one case, or the _pro rata_ share of total costs, in the other, are the less; and nothing can be carried from C to B unless it can be delivered at B at a price as low as that of goods made at A and transported at the rate just described. If the costs of making at A and C are equal and there are the three carriers seeking traffic, as a.s.sumed, the result naturally is to give all the business to the one who will bid the lowest for it. Either railroad will bid as low as the variable costs which the traffic occasions; while the owners of s.h.i.+ps will bid no lower than the rate which covers costs of both kinds.[2]

[2] If carriers by water are in that intermediate state in which their capacity is only partially used, they also may offer to take some traffic for an amount which only covers variable costs; but this condition does not naturally become in their case semipermanent, as it does in the case of railroads.

[Ill.u.s.tration: RAILROAD _____ __________________/ / _ __/ ___ A __ __ B / / ____ / ___________________/ RAILROAD ]

_The Case of Railroads having Common Terminal Points._--In the fourth case there are, besides the other carriers, two railroads between A and B which compete for the traffic at these terminal points, but not at intermediate ones. Their facilities for through traffic are alike.

The local traffic on the different lines is unlike, since it is affected by the character of the regions through which the railroads pa.s.s; but the charges made for local traffic are governed by the comparatively simple principles which we first stated. In contending for freight to way stations we may say that the railroad has to compete with wagons upon the highway, but with nothing more efficient.

The charges for local freight may therefore be extremely high, while, if the railroads are really competing as vigorously as pure theory requires, and if the normal results of compet.i.tion are completely realized, the rate which can be maintained between A and B for any articles carried will be no higher than those which cover the variable costs entailed on the route which is the less economical of the two.

The line to which this test a.s.signs the traffic between A and B must then stand the further tests we have described--those involved in contending for business with carriers using respectively the water route and the railroad from C to B.

_A Condition leading to a Reduction of Fixed Costs._--It is safe to a.s.sume that one of the two railroads from A to B has more local traffic than the other. It may be that even with this advantage its total returns of all kinds may fall short of covering its total outlays. In that case the total returns of any less favorable route must fall still further short of the amount necessary for covering all outlays; and if we adhere to the a.s.sumption that neither consolidation nor anything resembling it takes place, we have a case in which both railroads must undergo reorganization. The fixed charges of the better route must be scaled down and the creditors of this railroad must accept the loss, while on the other route the fixed charges must be reduced still more and the creditors must suffer a larger loss. It goes without saying that the prospect of such a calamity means consolidation. It is evident what alternative compet.i.tors face in cases in which heroic compet.i.tion goes on to the bitter end. As a rule this is an unrealized alternative. The mere prospect of the calamity connected with it is bad enough to put an end to the independent action of the different railroads. With the facilities for combination which now exist a far smaller inducement suffices to bring this about.

[Ill.u.s.tration: RAILROAD ___________________________________ A ___________________________________ B RAILROAD ]