Second-Best Pricing for the U. S. Postal Service

Abstract

The Postal Reorganization Act was passed by Congress in 1970 to change a funded government department (the Post Office Department) into an autonomous public corporation, the U.S. Postal Service, directed to break even except on operations specifically subsidized by Congress. According to the Postal Service's own claims it operates under economies of scale, so marginal cost pricing would cause it to incur deficits.' If such economies of scale exist the Postal Reorganization Act, by imposing a budget constraint, effectively requires the Postal Service to choose from a set of second-best prices which will exceed marginal costs. But because the Postal Service provides some services that are imperfect substitutes for those offered by private firms no currently available second-best pricing rule exactly fits the situation it faces. Our aim is to derive and assess an optimal second-best pricing rule for a budget-constrained public sector firm such as the U.S. Postal Service, operating under economies of scale when at least one of its goods or services stands as an imperfect substitute or complement to a good or service in the private sector.