New York City just auctioned off some more medallions. What did they go for? About $300,000. What should one cost? Ask Andrew Chamberlain:
...let’s do the math. Given a medallion cost of $300,000, how much does a cabbie have to make to justify buying one? Assuming he’ll use it for 20 years, and assuming a 5 percent discount rate—the forgone return he could’ve earned on a similar investment—he’d need to earn about … $28,300 a year.
That’s not much. So how much do taxi drivers actually earn? According to the New York Times here and here, most drivers pull in about … $30,000 a year.
Chamberlain also questions whether the medallion system makes sense in the first place. My knee-jerk free market reaction is to say no. That being said, it is easy to imagine that a congestion tax on Manhattan taxis is optimal. How close do current quantity restrictions come to such a tax? Hard to say, but at the very least non-Manhattan driving probably does not require medallions. Should we also allow taxis to raise their prices when it is raining? I have heard that Tokyo residents hailing a taxi will hold up two fingers to pay twice the state fare, three fingers to triple it, and so on.
Addendum: Daniel Akst notes that this calculation assumes a very low shadow price for labor. I'll predict that the immigrant drivers have discount rates higher than five percent a year, as well. That only intensifies the puzzle. On the other side of the equation, you can sell the medallion after twenty years.
Activity:
Read the article above.
Questions:
1.) The article indicated that in 2004, a medallion was sold at $300,000. Here comes some update. In May 2007, a taxi medallion was sold in NYC for a price of $600,000. According to supply and demand analysis, is it a surprise to you that a medallion can be sold at such a high price?
2.) Which one will be higher, the price paid by passengers for taxi rides with the medallion system in place or the price they would have paid if there is no medallion system?
3.) Who will favor the medallion system? Why?
4.) Illustrate consumer surplus, producer surplus, and the loss in total surplus (deadweight loss) in a supply and demand diagram caused by the medallion quantity control.
Answers:
1.) The instructor might need to briefly describe the medallion system in the New York City. So the students can understand the situation. The system was introduced to the city decades ago as a quality standard. A taxi driver must obtain a medallion in NYC to be considered as “legal”. Over time, though the population in NYC has increased dramatically, the number of medallions stays almost unchanged. That has caused an obvious problem – not enough taxi rides for passengers who would like to get them.
Given a huge demand and limited supply, it is not a surprise that the price of medallion can reach a record high of $600,000 in 2007.
2.) The price passengers pay for a ride will be higher with the medallion system compared to the price without the medallion system. This can be shown by the following (next page):
In this case, the passengers will have to pay a higher price; these passengers are worse off since they should have paid a lower price. The drivers who do have a medallion will benefit since they receive a higher price; But as a whole, total surplus will drop in the market.
P* and Q* represent the price and quantity without medallion system.
Pm and Qm represent the price paid by passengers and quantity with the system in place.
3.) the taxi drivers who already have the medallion will favor the system given that they receive a higher price Pm instead of P* (and if they decide to sell the medallion in the future, think about it, $600,000!).
4) Using the same graph, consumer surplus and producer surplus can be illustrated.
