Author’s note:
This series of blogposts will be my paraphrased notes on a lecture given by Murray Rothbard called “The American Economy and the End of Laissez Faire“. This means the post will contain some word for word transcriptions of Rothbard’s words and some editorializing and rephrasing of my own. I will not distinguish between the two.
Elastic & Inelastic Demand Curves
Every company faces what’s known as an elastic demand curve. In other words, if you cut prices, you increase your sales, and potential revenues can go higher. For example, if wonderbread cut the price of their bread from $1.00 per loaf to $0.60 per loaf (and all other bread prices remained the same), they’d make a lot more money because many consumers would switch from buying other brands to buying wonderbread. This is an elastic demand curve.
Every business market has an elastic demand curve. On the other hand, demand curve for industry is much less elastic, and can even be inelastic. For example, if you cut all bread prices across the board revenues would likely fall, price cutting must occur asymmetrically in order for elastic demand curves to be realized. This means if you can organize a cartel around an inelastic supply curve, then you can cut the production and raise prices in such a way that total revenue increases, these revenue increases can then be parceled out amongst cartel members.
For example, if you could get everybody in a competing industry to increase prices across the board by 10%, revenue will increase a lot more than sales will decrease, but price increases must be uniformly distributed in order for this to be successful. In such a scenario businesses are happy with their increased profits but consumers are hurt by increased prices (with no increased quality in service). The only way to achieve such uniform price increases is with a cartel.
Jay Gould was interesting historical figure not because he was a great builder or a great business manager, his main goal in life was to bust up railroad cartels. He was known as “the rate buster”, and he absolutely hated cartels.
His primary strategy was simple, acquire a railroad that was involved in a cartel agreement and then immediately start undercutting the rate agreements.
Gould recognized that in environments of artificial inelastic industry supply curves, like in the case of railroad cartels, one player undercutting the cartel rates stood to make enormous profits over their competitors. Unlike in the situation of a cartel raising revenues by restricting supply and decreeing uniform price increases, undercutting in such cases was actually good for both the business cutting rates and the consumers, because the consumers were getting cheaper prices while the business is making more profits.
This is precisely way Gould engaged in his competitive business strategies of seeking out existing railroad cartels and undercutting them, essentially every railroad cartel was a sitting duck of unclaimed profit margin. This proved to be a remarkably profitable strategy for Gould, and he was absolutely hated for it.
In the same way that union participants hate strike breakers (hence the ‘scab’ pejorative), cartels hate price rate under cutters. Generally, the people unions hate the most are not the employers, but the non union ‘scabs’ that take the jobs at the market rate, rather than trying to hold business operations hostage in demand for higher wages.
Gould would look for high profit margin cartels and move in on them specifically with the strategy of undercutting their rates. He was called a ‘disturber of the peace’ by his detractors for doing this and it was this single strategy that made Gould’s entire career as a “railroad robber baron”.
Gould first got his start by buying up stock in small railways during the panic of 1857. In 1869 he successfully bought enough gold bullion to spark the panic of Black Friday on September 24, when the greenback (irredeemable fiat note) premium over face value fell on a gold double eagle from 62 percent to 35 percent. Gould lost these profits in lawsuits.
In 1873 Gould attempted to take control of Eerie Railroad by recruiting foreign investments from Lord Gordon-Gordon, but Gordon reneged on their deal and cashed out his stock bonus immediately. After this event, Gould acquired Union Pacific while it’s stock price was depressed from the panic of 1873 which is where he began to employ his cartel undercutting strategy.
By 1879, Gould gained control of the Missouri Pacific Railroad and the Denver and Rio Grande Railway. By this time he controlled 10,000 miles (16,000 km) of railway, about one-ninth of the rail in the United States.
He then obtained a controlling interest in the Western Union telegraph company and in the elevated railways in New York City after 1881. He had controlling interest in 15 percent of the country’s railway tracks by 1882.
In 1889, he organized the Terminal Railroad Association of St. Louis which acquired a bottleneck in east–west railroad traffic at St. Louis, but the government brought an antitrust suit to eliminate the bottleneck control after Gould died.
Because of his successes in these strategies Gould became a notorious character hated by all. Consumers, unfortunately, did not understand Gould’s benefit to the industry, while they enjoyed lower railroad rates because of him, they did not understand the nuance between Gould and other so called “Railroad Robber Barons”.
Gould was a self made man, he fit the image of Hill, Carnegie, and Rockefeller. These men were all born with no capital and poor parents. Gould was short (5 ft tall) and thin. He was self taught and not formally educated. In fact, very few successful people attended college in those days in that period. It was not unheard of for business moguls to begin working at the age of 12 and be millionaires by the age of 20, with savvy business sense and without the help of a formal college education.
Gould was a self taught railroad surveyor, speculator and financier. He was cool, detached, and emotionless. In the long run, Gould benefited the railroad industry & consumers immensely by forcing them to compete, however, he made a lot of enemies on this path and is still vilified as a “robber baron” to this day.
