South-Western College Publishing - Economics  
A Postal Rate Increase? AGAIN???
Subject The US Postal Service will seek another rate increase sometime in 2005.
Topic Supply and demand; Market Failure, Regulation, and Public Choice; Production and Costs; Monopoly
Key Words

Postal Service, rate increase, Postal Rate Commission

News Story

The US Postal Service will probably be seeking another postage rate increase in 2005 to cover what it calls "inflationary pressures."

The USPS faces a number of cost increases lately, including an inability to tap savings in how it contributes to a pension fund, as well as reductions in demand for its services as people increasingly use email and online payments. Most analysts expect at least a double-digit percentage increase in rates, raising the cost of a first-class postage stamp to at least $0.41, up from $0.37 currently-an increase of almost 11%.

The USPS is regulated as a natural monopoly, in which one firm can better service the market (here, home mail delivery) better than multiple firms, because of the high startup costs, but very low marginal costs. The Postal Service must apply for rate increases to the Postal Rate Commission, and given the length of time the Commission requires to make a decision, any request made next year will not likely take effect until 2006. The USPS posted a profit of almost $3 billion in the first nine months of its 2004 fiscal year. Still, the Postal Service anticipates a continuing reduction in demand for its services, as first-class deliveries fell 1.4% over that same time. It has been reducing its work force to cut costs, but still must make deliveries to 1.7 million new addresses each year.

Questions
1.

If the USPS is seeking a rate increase in part to cover the reduced demand for its services because people are increasingly using online payment systems and other forms of communication, will the rate increase hurt the Postal Service? Illustrate your answer with a graph of supply and demand.

2. The Postal Rate Commission sets the allowable postage rate based on what it considers to be a "normal" business rate of return. Illustrate with a graph what a regulated natural monopoly's "normal return" would be.
3. Does the fact that the Post Office made a $3 billion profit for the first nine months of their fiscal year indicate that they are earning more than a "normal return?" Why or why not?
Source Nicole Harris. "Postal service to seek rate increase." The Wall Street Journal, 24 November 2004. A3.

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