Abstract
The US Postal Service (USPS) provides “market-dominant” services on an exclusive basis, e.g., first class mail, and “competitive” services in markets with rivals, e.g., parcel delivery. Rivals have long complained that USPS underprices if not cross-subsidizes its competitive offerings. I ask what prices of the monopoly and competitive services maximize net economic welfare across the market-dominant and competitive service markets. With perfect competition, USPS should charge the market price and use the profits to finance reductions in market dominant service prices. If the regulated firm faces a fringe, Ramsey rules hold based on the elasticity facing that firm, recognizing fringe supply share and elasticity. If a rival offers a differentiated product, we find, following Prieger (1996), that the regulated firm’s price in that market should exceed the Ramsey price because the rival sells too little. This price will be the target if pricing in the differentiated competitive market is simultaneous rather than sequential. Application is complicated if a publicly-owned postal operator is not profit-maximizing.
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Notes
- 1.
Postal Regulatory Commission, Revised Notice of Proposed Rulemaking, Institutional Cost Contribution Requirement for Competitive Products, Docket No. RM2017-1, Order No. 4742 (Aug. 7, 2018).
- 2.
United Parcel Service, Inc. v. Postal Regulatory Commission, Petition for a Writ of Certiorari, Supreme Court of the United States (Dec. 26, 2018), available at https://www.supremecourt.gov/DocketPDF/18/18-853/77552/20181226122249306_UPS%20Petition%20for%20Cert.pdf. The Supreme Court’s denial of a writ of certiorari is at https://www.supremecourt.gov/orders/courtorders/052019zor_1bn2.pdf. The opposing brief filed by the Solicitor General of the US Department of Justice on behalf of the Postal Regulatory Commission is at https://www.supremecourt.gov/DocketPDF/18/18-853/95477/20190405110310785_18-853%20UPS%20-%20Opp.pdf. The central legal issue is whether the PRC has the discretion under PAEA to define attributable costs as it did, a question of administrative law more than economics as such.
- 3.
Task Force on the United States Postal System, United States Postal Service, A Sustainable Path Forward (Dec. 4, 2018) at 54, available at https://home.treasury.gov/system/files/136/USPS_A_Sustainable_Path_Forward_report_12-04-2018.pdf
- 4.
In general, net economic welfare includes both producer and consumer surplus. In the models below, I assume that the regulator is maximizing welfare subject to a requirement that the PO is just covering cost, that is, it is getting no producer surplus. However, when we add in rivals, I include any surplus they may get in the overall welfare calculation.
- 5.
This rules out applications where the market-dominant service is an input to the competitive service, in particular, where the USPS’s “mail” service is used to deliver “parcels” or is provided under other worksharing arrangements.
- 6.
If goods are substitutes or complements, the elasticity expressions here become matrices of own price and cross price elasticities (Scott 1986).
- 7.
Even with this ambiguity, if a PO cannot cover its incremental—fixed and variable—costs of supplying the competitive service at the optimal price, it should not enter if the market is already competitive. The optimal entry question is more complex in settings below where, because of product differentiation, the “competitive” market is less than fully competitive. If so, PO entry can cause price to fall, generating consumer benefits that it does not capture.
- 8.
There should be a test to see if PO entry increases welfare, which if the entered market is competitive will be equivalent to asking if the price in the competitive market is sufficient to cover the PO’s fixed and variable costs of entry. See supra n. 7.
- 9.
Prieger (1996) finds a somewhat similar term.
- 10.
See supra n. 8.
- 11.
These remaining three terms constitute what Salop and Moresi (2009) call, in the context of merger analysis the “Generalized Upward Pricing Pressure Index” or “GUPPI.” There is an important difference, however. The GUPPI is calculated taking the rival’s price as fixed, because it is applied to simultaneous pricing models where one price does not influence another. When the rival sets price based upon the dominant firm’s price, in a sequential model as here, the diversion ratio needs recognized that the rival will raise price. Hence, in this setting the diversion ratio can be negative, whereas it is always positive in the simultaneous pricing models used in merger assessment.
- 12.
Conversely, to the extent that the PO’s competitive product is a complement to differentiated services in other markets, its price should be lower than that prescribed by the Ramsey inverse elasticity rule, also to increase output in market where differentiation implies too little. Prieger (1996) makes this point as well.
- 13.
One could say, because Ramsey pricing is itself second-best, that this is a “third best” pricing argument.
- 14.
In practice, these potential benefits accruing from economies of scope—the existence of common costs—have to be weighed against potential harms from discrimination and cross-subsidization that can follow regulated firm participation in unregulated markets (Brennan 1987).
- 15.
In a repeated game, perhaps the PO and its rival would institute the collusive price. I am not considering that here, in part because models of firm interaction used in merger analyses, as noted above, use one-shot games. If one thinks tacit collusion between a PO and its rivals in, say, parcel delivery, is likely, one might expect that a welfare-maximizing regulator might effectively prevent it by forcing the PO to charge the one-shot equilibrium price. But this could be a subject for future investigation.
- 16.
Postal Regulatory Commission, Notice of Proposed Rulemaking for the System for Regulating Rates and Classes for Market-dominant Products, Statutory Review of the System for Regulating Rates and Classes for Market-dominant Products, Docket No. RM2017-3, Order No. 4258 (December 1, 2017), at 37.
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Brennan, T.J. (2020). Pricing “Competitive” Postal Products. In: Parcu, P.L., Brennan, T.J., Glass, V. (eds) The Changing Postal Environment. Topics in Regulatory Economics and Policy. Springer, Cham. https://doi.org/10.1007/978-3-030-34532-7_7
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