Smchap04

In the fall of 2011, two taxi medallions in New York City sold for over $1 million each.  Only taxis with a medallion issued by the City of New York are permitted to legally operate as licensed taxis because of a law dating back to 1937.  Under this law, only 13,237 taxi medallions may be issued, thereby limiting the number of taxis which may operate in New York.

While the city government may have acted with good intentions in 1937, seeking to ensure minimal standards of quality for taxis and reducing corruption in the taxi business, the law has now severely, artificially limited the number of taxis available.  In essence, the government has acted like an inefficient monopolist by limiting q arbitrarily and creating an artificially high p.  The city auctions new medallions very infrequently (the last auction was in 2006, and only 308 new medallions were issued) and sales of existing medallions are rare because of high profits derived from the inflated fares.  Because of the extreme rarity of medallions and the artificially high returns, medallions command extremely high prices, such as the aforementioned $1 million at auction.

Several data points, other than mere intuition and observation of the limited quantity of medallions, support the notion that the government has created an arbitrary monopoly.  The first data point is the extremely high price of medallions at sale.  If the price of an asset is equal to the value of its discounted cash flows, then the sale of the medallions for $1 million three years ago implies an extremely high discount rate or extremely high cash flows.  The taxi-business should command a relatively low discount rate because it is relatively low risk.  This implies that cash flows to the owner of the medallion are very high in order to command a market price of $1 million.  Such high cash flows and high profitability relative to the other assets required (a car and a driver) imply that returns are higher than they ought to be in a competitive market.  An even stronger data point can be seen in comparing fares charged by medallion taxis to fares charged by unlicensed competitors such as Uber or Lyft.  Analysis of fares for typical rides show that both of these services are 10.0% (or more) cheaper than ordinary taxi service.