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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]

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Second-Best Pricing for the US Postal Service

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

  2. 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?

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

  4. 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

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

  6. Derivation of price Utility function Subject to income constraint Demand function

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

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

  9. Implications • If Ekj = 0, then optimal pricing a la 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

  10. 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

  11. 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

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