Second-Best Pricing for the US Postal Service Roger Sherman and Anthony George Presented by Ian Fetters

US Postal Service operates under economies of scale Marginal cost pricing  deficits Postal Reorganization Act [1970] Organized Postal Service, formerly Post Office Department into corporation Goal: to break even – given budget constraint How should the USPS price?

Conditions Economies of scale, so MC pricing  deficit Budget constraint limits deficit Some services have substitutive or complementary relationships with private sector services

Previous models Ramsey, Boiteux – framework for second-best models Davis/Whinston, Baumol/Bradford, Lerner – models assuming no public/private sector interactions Mohring – considers cross-price elasticities in public sector, but not private sector Bergson – considers cross-price elasticities, but no budget constraint

Assumptions No intermediate goods No interdependencies between goods Private firms do not respond to public sector prices

Derivation of price Utility function Subject to income constraint Demand function

Derivation of price Seek to maximize welfare Constraints: incomes and costs equal, Firm only earns B

Derivation of price Substitute for optimal price Solve for derivation from MC in terms of elasticity

Implications If E kj = 0, then optimal pricing a la Baumol/Bradford If E kj =/= 0 among public sector services, then situation similar to Mohring If E kj =/= 0 between public/private sector services, then situation similar to Bergson

Implications As budget constraint is more important, α  1, price further from MC, substitute/complementary services more important If private service tends to be complement to public, public service will be cheaper than if ignoring complemancy

Implications USPS estimates MCs very low –α approaches 1, influence of private sector less important Others estimate MC of USPS higher –α approaches 0, must consider private sector when pricing in public sector Estimates of MC increase over time