Transcript Second-Best Pricing for the US Postal Service

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 = 0, then optimal pricing a la
kj
Baumol/Bradford
• If Ekj =/= 0 among public sector services, then
situation similar to Mohring
• If Ekj =/= 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