FTC Staff Comment Before the Postal Rate Commission Concerning Preferred-Rate Mail Study

COMMISSIOP
APPROVED
Comments of
The Bureau of Economics,
The Burea u of Consumer Protection,
and The Bureau of Competition of
The Federal Trade Commission
Submitted in PRC Docket No. SS 86-1
Preferred-Rate Mail Study
April 20, 1986
These comments represent the views of the Bureaus of Economics,
Consumer Protection, and Competition and do not necessarily
represent the views of the Federal Trade Commission or
any individual Commissioner. The Commission has, however,
authorized the staff to submit these comments. Inquiries
regarding these comments should be directed to Richard Higgins,
Bureau of Economics, Federal Trade Commission, Washington, DC, 20580

I. INTRODUCTION
The Bureau of Economics, Bureau of Consumer Protection, and Bureau
of Competition of the Federal Trade Commission (FTC) offer comments in
response to the Postal Rate Commission's (PRC) request of March 10, 1986. 1
The 	FTC's responsibility 	for 	the enforcement of 	the antitrust laws and 	its
consumer 	protection 	mission 	give 	it 	expertise 	in 	matters 	relating 	to 	the
competition 	and 	consumer 	welfare 	effects 	of 	governmental 	policies.
Accordingly, the FTC has intervened in recent years in a number of matters
before the PRC,2 and FTC officials have commented on a number of postal
issues. 3 	As in these earlier contributions, our present comments are limited
to those areas in which FTC experience with competitive, consumer welfare,
and 	economic 	issues 	in 	other 	markets 	offer 	a 	useful 	perspective 	for 	the
Postal Rate Commission.
Congress 	will 	use 	the 	PRC 	study 	to 	determine 	policy 	regarding
preferential 	rates. 	Ultimately, Congress 	must 	decide 	whether some 	mailers
1 Based 	on 	the 	authority 	inherent 	in 	Section 	6 of 	the 	Federal Trade
Commission 	Act, the 	FTC is authorized 	to 	intervene 	in agency proceedings
on 	matters 	within 	its 	expertise, 	A & 	B Freight 	Lines. 	Inc. 	v. 	FTC, 	1980-1
Trade Cas. P63,127, (D.D.C., 1980), aff'd, No. 80-1264 (D.C. Cir. January 26,
1981), cert. denied, 452 U.S. 962 (1981).
2 	See, 	~, 	Comments 	of 	The 	Bureau 	of 	Economics, 	The 	Bureau 	of
Consumer Protection, and The Bureau of Competition of The Federal Trade
Commission Submitted 	in 	PRC Docket No. RM82-3, Rate and 	Classification
Proposals; Test Period Rule, November 4, 1982.
3 	Statement 	of 	James 	C. 	Miller, 	III, 	Chairman, 	Federal 	Trade
Commission, On 	United 	States Postal 	Service, Before 	The Subcommittee on
Economic 	Goals 	and 	Intergovernmental 	Policy 	of 	the 	Joint 	Economic
Committee, June 21, 	1982. Testimony of Timothy J. Muris, Director, Bureau
of 	Consumer 	Protection, 	on 	"The 	Provision 	of 	Telecommunications 	and
Information 	Services 	by 	the 	Federal 	Government 	in 	Competition 	with 	the
Private 	Sector," 	before 	the 	Government 	Information 	and 	Individual 	Rights
Subcommittee 	of 	the 	Committee 	on 	Government 	Operations, 	U.S. 	House 	of
Representatives, February 25, 1982.

should receive preferential rates. 	If subsidies to preferred mailers are to be
reduced, how should this be done? 	In particular, should subsidies be reduced
across the board or should some preferences be eliminated entirely?
The comments presented 	here will discuss some of the factors 	bearing
on 	the 	costs 	and 	benefits 	of 	the 	current 	preferential 	rate 	structure.
Specifically, we will point out some of the hidden costs which result from
the 	preferential 	treatment which 	is currently given to some mailers. 	While
the 	final 	assessment 	of 	costs 	and 	benefits 	is 	of 	course 	for 	Congress 	to
make, 	it 	is 	important 	that 	Congress 	be 	aware 	of 	all 	the 	costs 	that 	are
actually involved.
Our 	analysis 	indicates 	that 	the 	current 	pricing 	policy 	for 	preferred
mail 	leads 	to 	the 	inefficient 	allocation 	of 	resources. 	Because 	subsidized
prices 	are 	below 	true 	economic 	costs, 	preferred 	mailers 	are 	encouraged 	to
use subsidized mail services excessively. 	In particular, preferred mailers will
use 	subsidized 	mail 	when 	other 	forms 	of 	message 	delivery 	would 	be 	more
cost-effective. 	They will inefficiently shift to subsidized mail services from
the 	unsubsidized 	mail services they otherwise would 	have 	used. 	They will
stop 	performing some activities, such as maintaining accurate mailing 	lists,
since 	access 	to 	subsidized 	rates 	reduces 	the 	private 	return 	to 	these
activities. 	Finally, they will undertake activities which allow them to exploit
their 	access 	to 	subsidized 	mail, 	even 	when 	they 	are 	less 	efficient 	at
performing these activities than others who do not have access to preferred
rates.
The 	remainder 	of 	our comments are 	organized 	as 	follows. 	First, 	we
estimate 	the social losses which 	resutt from 	the excessive use of subsidized
mail 	by 	preferred 	mailers. 	Second, 	we 	discuss 	particular 	examples of 	the
2

types of distortions which lead to the estimated social losses. 	We conclude
with a summary of our findings and recommendations.
II. SOCIAL LOSSES DUE TO SUBSIDIZATION OF PREFERRED MAILERS
Efficient production and allocation of goods and services requires that
the value of the last unit produced be equal to the social cost of producing
it." 	As 	a 	result, 	economists 	often 	evaluate 	the 	efficiency 	of 	markets 	by
determining 	whether 	prices 	are 	equal 	to 	marginal 	costs. s 	Using 	this 	test,
the 	subsidization 	of 	postal 	rates 	will 	clearly 	be 	inefficient 	if 	the 	prices
charged preferred mailers are set below marginal costs.
The 	prices 	charged 	subsidized 	mailers 	appear 	to 	be 	below 	marginal
costs. 	Currently, subsidized mailers pay a price which is set slightly above
attributable costs. 6 	Studies of economies of scale suggest that almost all
postal costs are variable, and thus should be attributed if prices are to equal
" 	If 	marginal 	social 	benefits 	are 	less 	(greater) 	than 	marginal 	social
costs, net social benefits would increase with less (greater) production. For a
more detailed discussion of the conditions which are necessary for efficient
allocation 	of 	resources 	see, 	Douglas 	F. 	Greer, 	Business. 	Government. 	and
Societv (New York: Macmillan, 1983), pages 14-37.
S This argument assumes 	that 	the 	marginal social 	benefit of the 	good
or service equals the 	benefit to the consumers who make the purchase. 	In
the case of preferred mail, it could be argued that the marginal social value
of the additional mail is greater than the marginal value to the individuals
or organizations who pay 	for 	it. 	If Congressional assessment 	of the social
value of providing preferred mail services is greater than is indicated by the
private demand 	for 	preferred mail, then our estimates of social loss should
be reduced.
6 	Attributable 	costs 	are 	costs 	which, 	in 	the 	judgment 	of 	regulators,
are "caused" by a 	particular type of mail. 	Other costs, which are common
or joint costs, are referred to as institutional costs.
3

long-run 	marginal 	costs. 7 	However, 	only 	70% 	of 	all 	costs 	are 	currently
attributed, indicating that preferred prices are likely to be below marginal
costs. 8
When 	economies 	of 	scale 	are 	low, 	marginal 	cost 	pricing 	implies 	that
almost 	all 	costs 	will 	be 	covered 	by 	the 	revenues 	earned 	from 	mailers.
Currently, only 	regular 	mailers are charged 	prices 	which 	cover 	total 	costs.
This suggests that regular second and third-class prices may be set close to
marginal 	costs. 9 	In 	the 	following 	analysis 	we 	assume 	that 	this 	is 	true. 10
By making this assumption, one can estimate the extent to which the prices
7 For example, see the discussion 	in James Miller and 	Roger Sherman,
"Has 	the 	1970 	Act 	Been 	Fair 	to 	Mailers?" 	in 	Roger 	Sherman 	(ed.)
Perspectives on 	Postal Service Issues (Washington, D.C.: American Enterprise
Institute, 1980).
8 Some 	costs 	which 	are 	currently 	viewed 	as 	institutional costs appear
to 	vary 	with 	volume, 	confirming 	the 	findings 	of 	the 	economies 	of 	scale
studies. 	For example, increases in mail volume would increase the amount of
equipment ip use, and would thus require proportional increases in equipment
maintenance, 	yet 	in 	the 	1984 	Recommended 	Decision 	the 	Postal 	Rate
Commission 	classified 	only 	6.1 % of 	equipmen t 	main tenance 	as 	attri bu ta ble
costs. 	United 	States 	of 	America 	Postal 	Rate 	Commission, 	Appendices 	to
Opinion 	and 	Recommended 	Decision, 	Docket 	No. 	R84-1, 	(Washington, 	D.C.:
Postal Rate Commission, 1984). 	Similarly, only 48.6% of window service labor
costs were viewed as attributable, but surely if mail volume were to double
the 	Postal 	Service would 	find 	it necessary to nearly double the number of
clerks 	to 	provide 	comparable 	service. 	Similarly, 	the 	rate-making 	process
appears 	to 	attribute 	too 	little 	of 	supervisor, 	technician, 	and 	postmaster
salaries.
Of course, 	the 	problem of calculating attributable costs arises because
postal rates are regulated and entry is largely prohibited. 	If free entry were
allowed and competition were to arise, prices would be set by the market to
align 	with costs, avoiding the need to make the allocations discussed in the
text.
9 The extent to which this is true will depend on how the costs which
postal 	regulators 	currently 	classify 	as 	institutional 	are 	allocated 	in
determining the prices of different classes of regular mail.
10 	While 	this 	assumption 	appears 	to 	be 	sensible, 	given 	available
information, 	additional 	work 	to 	measure 	marginal 	costs 	and 	economies 	of
scale in postal markets test would be desirable.
4

charged 	preferred mailers are below 	marginal costs and estimate the social
losses which result from this subsidization.
The 	social 	losses 	which 	result 	from 	the 	disparity 	between 	prices and
marginal 	costs 	are 	estimated 	using 	standard 	economic 	analysis 	in 	the
Appendix 	to 	this comment. 	The loss measure 	is 	based 	upon 	the 	following
reasoning. 	When 	the 	amount 	of 	mail 	sent 	increases, 	the 	value 	of 	each
additional unit declines. 	For example, the first and second solicitations sent
to any individual in a given 	year are more likely to generate contributions
than the third and fourth solicitations. 	The value of each unit of mail can
be measured by how much the mailer is willing to pay to send it. 	When the
mail is subsidized, preferred mailers are induced to send additional mail that
they 	would 	not 	have 	been 	willing 	to 	pay 	for 	at 	the 	regular 	price. 	We
assume that the price of unsubsidized mail is set at the marginal cost to the
Postal 	Service 	of 	handling 	the 	mail. 	Hence 	the 	value 	of 	the 	additional
preferred 	mail sent as a result of the subsidy is less than its cost, resulting
in a social loss. 	By summing the losses which result from the sale of each
of 	the 	additional 	units, one can obtain a 	measure 	of the social loss which
results 	from 	the 	subsidy. 	It 	is 	the 	value 	obtained 	by 	performing 	this
summation which 	we report as the social loss which 	results from the postal
subsidy.
The subsidy 	payments 	which 	go 	to 	preferred 	mailers have historically
been 	near $1 	billion. 11 These 	payments do not directly 	reflect social losses.
11 	Congress 	paid 	the 	Postal 	Service 	$969.6 	million 	in 	1985 	to
compensate it for the delivery of preferred mail. Of this, $140.5 million was
payment 	for 	subsidized 	attributable 	costs 	which 	has 	been 	phased 	out. 	The
1986 	subsidy 	was 	originally 	estimated 	to 	be 	near 	$981 	million. 	U.S.
Government Accounting Office, Report to the Honorable William Dannemeyer,
House 	of 	Representatives: Subsidized Postage, (May 22, 	1985). 	(Hereinafter
cited as Subsidized Postage.) 	Recent budget cuts have reduced 	the subsidy
5

They are simply a large transfer from taxpayers to people who use subsidized
mail. 	As explained above, social losses result from the effect of the subsidy
in 	stimulating 	excessive 	use 	of 	the 	mails 	by 	preferred 	mailers. 	In 	the
Appendix we estimate, using measures of the elasticity of demand obtained
from 	PRe rate 	hearings, 	that this increase in 	mail 	usage 	is currently over
1.5 	billion 	pieces of second and third-class mail per year, which is slightly
over 10% of current preferred second and third-class mail.
Under the assumptions detailed in the Appendix, we estimate the annual
social 	loss 	at 	current 	prices 	to 	be 	approximately 	$20 	million 	dollars 	for
third-class 	mail 	alone. 12 	While 	the 	loss 	from 	subsidizing second-class 	mail
appears to be smaller, largely due to the more inelastic demand and smaller
volume 	of 	mail, 	it 	does 	increase 	the 	total 	estimated 	loss 	to 	about 	$30
million, using the same set of assumptionsY~
The social losses which we attribute to the current subsidy are sizeable.
However, the annual rate of losses prior to the March 9, 1986 rate increase,
which 	brought 	the 	prices 	charged 	preferred 	mailers 	closer 	to 	the 	Postal
Service's 	costs 	of 	serving 	these 	customers, 	were 	substantially 	larger. 	We
estimate 	that 	before 	the 	recent 	rate 	increase, 	the 	social 	loss 	due 	to
so tha t it is closer to $700 million.
12 The assumptions used in the calculation include: the assumption that
demand 	is 	linear, 	the 	assumption 	that 	marginal 	costs 	are 	constant, 	the
assumption 	that the price of regular mail 	is set at true marginal costs, the
assumption 	that 	the demand 	for 	preferred 	mail 	reflects the social 	value of
the mail, the assumption 	that there are 	no secondary effects as a result of
the 	subsidy, 	and 	the 	assumption 	that 	prices 	equal 	marginal 	costs 	in 	other
markets.
13 	Fourth-class 	mail 	and 	free 	mail 	for 	the 	blind 	are 	also 	subsidized.
We 	do 	not 	estimate 	the 	social 	losses 	which 	result 	from 	this 	subsidization,
since 	the 	smaller 	volume 	of 	these 	types 	of 	mail 	suggests 	that 	the 	losses
which 	will 	result are 	likely 	to be smaller than 	the 	loss which results from
the subsidization of second-class mail.
6

excessive 	use 	of 	second 	and 	third-class 	preferred 	mail 	was 	just 	over 	$50
million, of which $35 million is attributed to the subsidization of third-class
mail. Thus, we estimate that the recent rate adjustments have reduced social
losses by over $20 million.
The 	rate 	increase 	for 	preferred 	mail 	which 	took 	place in 	January 	is
estimated to have had 	an even larger effect. The annual social loss due to
su bsidiza tion 	before 	this 	rate 	increase 	is 	estimated 	to 	have 	exceeded 	$105
million. Roughly seventy-five percent of this loss results from the third-class
mail subsidy.
The Appendix identifies some important relationships which affect the
size of the estimated social loss due to subsidization of mail services. 	First,
it 	is clear that the size of the subsidy is crucial, since the social loss goes
up 	more 	than 	proportionally 	with 	increases 	in 	the 	price-cost 	distortion
resulting from 	the subsidy. 	Second, the elasticity of demand which is used
is 	important. 	The 	more elastic 	the demand, 	the 	larger 	the social 	loss 	that
will 	result 	from 	the subsidy. 	Third, the 	presence of distortions in 	related
markets 	affects 	the 	size of 	the 	estimated 	social 	loss. 	For example, 	if 	the
subsidization of preferred mail reduces demand for other types of mail for
which 	the 	price 	exceeds 	marginal 	costs 	then, 	additional 	social 	losses 	will
result from subsidization.
III. 	EXAMPLES OF DISTORTIONS WHICH R ESUL T FROM SUBSIDIZA nON
The social 	losses 	which 	result 	from 	subsidization 	of 	preferred 	mailers
are the result of several specific market distortions. One distortion that will
contribute 	to 	the 	social 	wastes 	which 	we 	estimate 	occurs 	when 	preferred
mailers 	substitute 	subsidized 	mail 	services 	for 	other 	more 	cost-effective
7

forms 	of 	message 	delivery. 	For 	example 	private 	carriers 	appear 	to 	be
particularly effective competitors for heavier third-class single piece mail. 14
To 	the 	extent 	that 	subsidized 	mail 	leads 	preferred 	mailers 	to switch 	from
methods 	of 	delivery 	that 	are 	more 	efficient 	than 	the 	subsidized 	postal
service, social losses will result.
Subsidies also provide preferred mailers with an incentive to shift from
unsubsidized mail services to subsidized mail services, even when the social
costs of the change in 	behavior exceed the associated benefits. IS 	Numerous
14 	In 	R80-1 	at 	page 	400 	the 	PRe 	recognizes 	that 	direct 	competition
from private carriers is present. Others have also recognized the presence of
direct 	competition. 	Sorkin 	reports 	examples 	of 	magazines 	and 	newspapers
switching to private carriers to deliver sizeable portions of their circulation.
Alan 	Sorkin, 	The 	Economics 	of 	the 	Postal 	System, 	(Lexington, 	Mass.:
Lexington 	Books, 	1980) 	And 	the 	presence 	of 	UPS, 	motor 	carriers,
consolidated 	shipping 	associations, 	and 	express 	delivery 	firms 	offer 	direct
competition in the fourth-class parcel post market.
IS 	For example, 	the 	in-county subsidy 	may 	have 	had 	this effect on
na tional 	pu blishers 	before 	recent 	changes 	made 	them 	ineligi ble 	for 	the
subsidy. 	Until 	recently, national publishers could designate a large county,
such as Los Angeles, as their "county of publication" and receive a sizeable
subsidy on all of the second-class mail they sent to residents of the county.
This structure of the subsidy encourages them to ship their publications to
the county for entry into the postal system in that county, even though this
involves handling the mail twice. 	Assuming that the in-county "Subsidy does
more 	than 	reflect 	the 	lower 	costs 	of 	handling 	mail 	which 	is 	destined 	for
residents of the county in 	which it is mailed, this double 	handling implies
that unnecessary social costs may be present.
A study done by the General Accounting Office identified six national
publishers 	which 	designated 	Los 	Angeles 	as 	their 	office 	of 	publication.
Originally, four 	of 	these six 	indicated 	that 	their office of 	publication was
outside 	this area. 	The subsidy 	to 	the six 	national 	newspapers 	amounted 	to
$3.6 	million. 	The 	total 	in-county 	subsidy 	from 	the 	federal 	government
amounted to around $72 million in 1985. 	Subsidized Postage.
By 	putting 	stricter 	eligibility 	requirements 	on 	the 	in-county 	subsidy,
Congress 	reduced 	significantly 	the 	distortions 	that 	arise 	from 	this 	subsidy.
Moreover, the recent changes cause the subsidy to be targeted better so that
a lower percentage of the funds go to unintended parties. 	Nonetheless, the
in-county 	subsidy 	is 	still 	worth 	more 	in 	large 	counties. 	As 	a 	result, 	the
subsidy 	still 	may 	go 	primarily 	to 	large 	populous counties 	which 	are 	more
likely to have adequate news/information networks than smaller rural areas.
8

possibilities 	for 	substitution 	among 	different 	types 	of 	mail 	exist. 	For
example, 	both 	letters 	and 	post 	cards 	can 	be 	used 	to 	convey 	personal
messages. 	Organizations tha t wish to con tact the public may use first-class
letters or post cards, third-class single piece mail, and third-class bulk mail.
The extent to which 	inefficient shifting across types of mail occurs can be
measured 	by 	the 	cross-elasticities 	of 	demand 	between 	different 	postal
services. I6 	While 	these 	cross-elasticities are 	fairly 	low, 	they 	indicate 	that
inefficient shifting across types of mail does take place.
Since subsidized 	mail 	users 	pay 	less 	for 	mail services, 	they 	have 	less
incentive 	to 	undertake 	certain 	activities 	which 	will 	reduce 	Postal 	Service
costs. 	For example, subsidized 	mailers will 	have 	less incentive to maintain
accurate mailing lists, since the costs they incur for misdirected mail will be
16 Economists 	use 	the "cross-elasticity of demand" as a 	statistic which
indicates 	the 	extent 	to 	which 	products are 	substitutes. 	This statistic 	is 	an
estimate 	of 	the 	percentage 	change 	in 	the 	quantity 	demanded 	of 	one
commodity which results from the percentage change in the price of another
commodity 	at 	the 	prevailing 	prices. 	If 	the 	value 	of 	the 	cross-elasticity 	is
greater 	than 	zero 	the 	products 	are 	substitutes. 	Larger 	values 	indicate
greater 	degrees 	of 	substitutability 	of 	the 	products. 	The 	table 	shown 	below
reports cross-elasticities which have been estimated:
Cross-Elasticity Estimates
(percentage change in quantity
of one type of mail/percentage
change in price of second type
mail)
letters/post cards
postcards/letters
letters/3rd class bulk regular
3rd class bulk regular/letters
post cards/3rd class bulk regular
3rd class bulk regular/post cards
by
Tolley
.0 I
.28
.03
.18
by
Sobin
.01
.12
.04
.25
.20
.03
Testimony of George Tolley in R80-1 USPS, vol. 21, appendix H.
Testimony of Bernard Sobin in R77-1, Changes in Rates of Postage Fees, vol.
IV, pp. 559-561.
9

lower. 17 	This 	possibility 	was 	recognized 	by 	the 	Postal 	Service 	when 	it
noted: "Fund raisers seldom purge or crosscheck their mailing lists, causing
households to receive the same solicitation three or four times, because it is
cheaper for the mailer to send duplicates than to clean his lists."IS
Subsidized 	mailers 	are 	also 	less 	likely 	to 	consider 	ways 	in 	which
mailings can 	be combined, since the cost of sending an additional piece of
mail 	is 	lower 	for 	them. In 	this case, as 	in 	the case of out-of-date 	mailing
lists, 	the 	postal 	service 	incurs 	real 	costs 	because 	it 	must 	handle 	a 	larger
volume of mail.
Mail 	subsidies 	also 	lead 	to 	social 	losses 	by 	encouraging 	subsidized
mailers, such 	as 	non-profit organizations, 	to enter 	markets 	where 	they can
exploit 	their 	access 	to 	lower 	postal 	rates 	even 	if 	they 	are 	inefficient
producers 	of 	relevant 	product. 	Moreover, 	the 	sizeable 	artificial 	advantage
granted to non-profit organizations will lead to non-profits replacing possibly
more 	efficient 	for-profit 	firms. 19 	Specifically, 	the 	reduced 	postal 	rates
granted 	to 	non-profit 	firms 	lowers 	their 	marginal 	cost 	of 	selling 	their
products, 	and 	thereby 	induces 	them 	to 	expand 	their 	sales 	and 	encourages
entry 	by 	more 	non-profit 	firms. 	The 	increased supply by non-profit firms
17 The General 	Accounting Office attempted 	to study 	this question 	by
sampling preferred mail, but stopped when it discovered that it was a more
sizeable task than had been envisioned at the outset. 	See Subsidized Postage.
18 U.S. Postal Service, The Necessity For Change,February 1976, page 38.
19 The entry of non-profit organizations in response to profits that are
attributable 	to 	subsidies 	has 	been 	observed 	with 	respect 	to 	other 	types 	of
subsidy. 	For 	example, 	Professor 	Henry 	Hansman 	observed 	that 	non-profit
organizations 	represent 	a 	higher 	percentage 	of 	the 	organizations 	in 	the
private nursing home, hospital, and primary, secondary, and vocational school
industries 	in 	states 	with 	higher 	state 	and 	local 	taxes 	than 	in 	other states.
"The 	Effect 	of 	Tax 	Exemption and 	Other Factors on 	Competition Between
Nonprofit and For-Profit Enterprise" (preliminary draft, December 1982).
10

results in a decrease in the output of for-profit firms. 	The non-profit firms
that enter in response to the subsidy will tend to be those firms that were
too inefficient to compete without the subsidy, whereas the for-profit firms
that 	are 	forced 	to exit are sufficiently efficient to compete in the market
under equal conditions. 	Thus, the net effect of the differential pricing is
that 	high 	cost 	producers 	replace 	low 	cost 	producers, 	increasing 	the 	total
resources necessary to produce any given amount of output.
Current 	postal 	regulations allow 	non-profit 	firms 	to use their reduced
rates 	even 	when 	the 	services 	they 	are 	offering 	are 	in 	direct 	competition
with for-profit organizations or when they are working cooperatively with a
for-profit 	firm. 	The 	only 	requirement 	is 	that 	the 	use 	to 	which 	the
non-profit 	mail 	permit 	is 	put 	must 	directly 	benefit 	the 	non-profit
organization. 20 	When any of the more than 780,000 non-profit organizations
use 	subsidies 	to 	compete 	in 	activities 	in 	which 	for-profit 	firms 	are 	more
efficient, 	social 	losses 	will 	result 	since 	final 	output 	is 	not 	produced
efficiently.21
While the postal subsidy is only a small part of the total subsidy which
flows 	to 	non-profit 	organizations,22 	it 	may 	nonetheless 	be 	large 	enough 	to
20 	There 	is 	some 	evidence 	that 	organizations 	do 	not 	use 	their 	m3iJ
permits 	as 	they 	were 	intended 	to 	be 	used. The General 	Accounting Office
reports that of "180 authorizations (for use of nonprofit mail rates) selected
for reverification, 93 of 146 reviewed to date were revoked because they no
longer qualify for nonprofit mailing privileges." Subsidized Postage, Appendix
I, p.S.
21 Over 300,000 non-profit organizations file IRS form 990s. 	However,
smaller non-profit organizations do not have to file these forms. As a result,
the total number of non-profit organizations is estimated to exceed 780,000.
22 	The 	total 	income 	of 	non-profit 	organizations
while 	the 	postal 	subsidy 	was 	less 	than 	one 	billion. 	As
subsidy 	is 	less 	than 	.3% 	of 	the 	funding 	that 	goes 	to
Business 	Administration, 	"Statistical 	Profile 	of 	the
I J
was 	$314.4 	billion,
a 	result, the 	postal
non-profits. 	Small
Nonprofit 	Sector,"

give 	non-profit 	organizations 	an 	important 	edge 	when 	they 	compete 	with
for-prof it 	firms 	in 	some 	ind ustries. 	Moreover, 	the 	use 	of 	the 	mails 	by
non-profit 	organizations 	in 	selling 	products 	and 	services 	to 	raise 	funds
appears 	to 	be 	on 	the 	rise. 	While 	available 	figures 	are 	not 	entirely
satisfactory, they suggest that "sales" are becoming an increasingly important
source 	of income 	for 	non-profit organizations. Indeed, 	they 	surpassed 	$200
billion in 1980. 23
Case 	studies 	indicate 	that 	non-profit 	organizations 	use 	their 	mail
subsidies 	to compete with 	for-profit organizations in some 	industries where
mail 	is an 	important input. 24 	Specifically, the 	travel, insurance, magazine,
and seminar industries often rely on the mails to reach customers, which can
advantage 	non-profit organizations relative to for-profit organizations. 	For
example, Dominick Schrello points out in 	his study of the seminar industry
that: 	"Presently ... 	(the) 	significant 	postal 	rate 	discount 	gives 	nonprofit
organizations 	a 	tremendous 	advantage 	compared 	to 	others 	in 	the 	public
seminar 	market 	place."25 	Evidently, large seminar organizers send over 60
Advocacy Current Topics, April 1985.
23 Sales figures 	not only include the sale of goods and services by the
non-profit organization, but the sale of assets which may have been obtained
through 	gifts 	or 	the 	investment 	of 	dues. 	Nonetheless, 	the 	change 	in 	sales
levels relative 	to other flows of funds suggests that the 	provision of goods
and 	services 	by 	non-profit 	organizations 	is 	on 	the 	rise. 	In 	1975, 	sales
accounted 	for 	65% 	of 	all 	funds 	flowing 	into 	non-profit 	organizations. 	By
1983, 	this 	figure 	rose 	to 	76%. 	Small 	Business 	Administration, 	Advocacy
Current Topics.
24 	For 	a 	more 	detailed 	discussion 	of 	cases 	cited 	in 	the 	text, 	see
Subsidized Postage.
25 Cited in Subsidized Postage, pa.ge 5.
12

million pieces per year, which means that access to subsidized rates has been
worth millions of dollars. 26
In another example, one association saved $705,000 over the course of a
year 	for 	an 	insurance 	company 	with 	which 	it 	was 	associated 	by 	mailing
information about insurance policies to its members. 27 	There also appears to
be 	direct 	competition 	between 	for-profit 	and 	non-profit 	magazines.28
Statements 	provided 	the 	PRC 	by 	officials 	representing 	for-profit 	travel
agencies 	and 	other 	businesses 	as 	part 	of 	these 	hearings 	suggest 	that 	the
value of the subsidies in the industry are similarly large.29
In sum, 	the 	replacement of 	for-profit 	producers 	by subsidized 	mailers
has 	the 	potential 	of 	generating 	large 	social 	losses. 	Our 	estimates 	of 	the
social losses resulting from subsidization include these losses. 	Private losses
which 	result 	as 	subsidized 	mailers 	edge 	out 	regular 	mailers 	are 	only
reflected 	in 	these 	calculations 	to 	the 	extent 	that 	the 	private 	losses exceed
private 	gains, 	which 	go 	primarily 	to subsidized 	mailers. 	This 	approach 	is
appropriate since our purpose is to measure the net social welfare effects of
26 	The General 	Accounting Office estimated 	that 	in 	1984 the subsidy
was worth $3.5 million 	if 60 million pieces were mailed. Subsidized Postage,
page 6.
27 The Postal Service initially felt that the association was formed as a
sham 	and 	revoked 	its 	license. 	However, 	it 	reversed 	its 	decision 	when 	it
appeared 	that 	a 	court 	would 	hold 	for 	the 	association. 	Subsidized 	Postage,
page 8.
28 Magazines 	such 	as 	National 	Geographic, 	Harpers, 	Ms., 	Smithsonian.
and Science 86 are preferred mailers. 	In contrast, Atlantic, Working Woman,
and Scientific American are not.
29 	See 	for 	example: 	Written 	statement 	provided 	by 	Howard 	Pollock,
American 	Society 	of 	Travel 	Agents, 	Inc., 	March 	10, 	1986; 	Statement 	by
Kenton Pattie, International Communication Industries Association, March 12,
1986; Statement of 	Joseph 	O'Neil, Business Coalition 	For 	Fair Competition,
March 12, 1986.
13

the 	subsidy. 	Moreover, 	it 	correctly 	leaves 	the 	job 	of 	articulating 	the
significance of private losses which result from subsidization to the affected
parties and the problem of weighing the significance of these arguments to
Congress. so
IV. CONCLUSION
The use of postal subsidies has both benefits and costs. 	Some benefits
and costs fall 	into areas of public policy that are beyond our expertise, so
we 	leave their assessment to others. 	A number of costs resulting from 	the
subsidies, however, involve the kinds of economic inefficiencies with which
we have become familiar. 	We are taking this opportunity to review some of
these costs and 	to urge that 	they 	be taken 	fully 	into consideration 	in any
ultimate assessment of costs and benefits.
The subsidization of preferred classes of mail leads preferred mailers to
use subsidized mail excessively. 	This inefficient increase in mail use results
from 	a 	number of distortions. 	Users of 	the 	U.S. 	Postal Service are led 	to
substitute 	inefficiently 	one 	form 	of 	mail 	service 	for 	another. 	They 	are
encouraged 	to 	use 	the 	mail 	to 	convey 	messages 	that 	would 	be 	more
efficiently conveyed in alternative ways. 	They are prompted to rely on the
Postal 	Service 	to 	perform 	tasks 	which 	would 	have 	been 	avoided 	if 	the
subsidy 	had 	not 	been 	present. 	And 	they 	are 	encouraged 	to 	participate 	in
businesses 	that allow 	them 	to exploit their access to subsidized 	postal 	rates
even 	when 	they 	are 	not 	efficient 	producers. 	Each 	of 	these 	effects 	reduce
social welfare.
so Similarly, 	we 	do 	not 	discuss 	here 	the 	private 	losses 	to competitors
of 	the 	Postal 	Service 	who 	are 	disadvantaged 	by 	the 	subsidy 	given 	to 	the
Postal Service for handling preferred mail.
14

While 	much 	of 	our 	analysis 	points 	to 	general 	concerns, some specific
conclusions and recommendations follow from this analysis:
--The inefficiencies which result from lowering the prices of subsidized
mail below marginal costs are not trivial. Estimates provided in the Appendix
suggest 	that 	annual 	losses 	are 	roughly 	$30 	million 	dollars 	and 	may 	have
exceeded $50 million dollars before the recent rate increase.
--Substantial 	portions 	of 	the 	non-profit 	subsidy 	seem 	particularly
inefficient 	and 	Congress 	should 	consider 	reducing 	them. 	For 	example,
non-profit 	organizations 	appear 	to 	be 	using 	their 	subsidy 	to 	enter 	into
competition 	with 	for-profit 	firms. 	To 	the 	extent 	non-profit 	organizations
are 	better 	suited 	for 	providing 	other 	services, 	this 	behavior 	will 	lead 	to
inefficiencies.
--Rate structures should 	be 	reviewed and amended 	where necessary to
give preferred rate mailers incentives to use the postal system efficiently.
--The 	current 	means 	of 	measuring 	"attributable" 	costs 	deserves 	more
attention, 	since 	it 	appears 	to 	lead 	to 	an 	understatement 	of 	the 	subsidies
received by preferred mailers.
Accurate 	assessment 	of 	the 	magnitude 	of all 	of 	the 	losses 	that 	result
from the inefficiencies discussed above is not possible with the data we have
at our disposal. 	However, there is reason to believe that there are sizeable
losses. 	Clearly, additional analysis of the Posta) Service's cost structure and
its 	implications 	is 	needed. 	While 	this 	is 	beyond 	the 	scope 	of 	the 	current
PRe 	project, 	we 	believe 	that 	this project does 	highlight 	the 	importance of
allowing 	the 	PRC 	and 	interested 	outside 	parties 	to 	have 	access 	to 	costs,
prices, and related data which is required to evaluate the efficiency of the
U.S. Postal Service.
15

Appendix: 	Deadweight Loss Calculation
The subsidization of a particular type of mail can affect the welfare of
individuals in two ways. First, there will 	be a transfer between the people
who 	fund 	the 	subsidy 	and 	the 	users 	of 	the 	subsidized 	mail 	services.
Currently, the transfer 	is almost $1 	billion. 	Second, there may be a social
loss, 	often 	termed 	a 	"deadweight 	loss," 	which 	results 	because 	society's
limited 	resources 	are 	incorrectly 	used 	to 	produce 	the 	subsidized 	service.
This loss results when the social cost of the resources used in producing the
subsidized service exceeds the social value of the service. It is equal to the
difference in the value of the output which is produced by the misdirected
resources and 	the value of the output which would have been 	produced 	if
the resources had been employed correctly.
Here we estimate one component of the deadweight loss attributable to
the 	preferred 	rates granted 	to certain types of second and third class mail.
Specifically, we focus on the distortion caused in the second and third class
mail 	markets 	because 	subsidized 	prices 	are 	depressed 	below 	the 	costs 	of
delivering 	postal 	services. 	We 	ignore 	social 	costs 	that 	result 	because 	of
expenditures 	by 	the 	government 	to oversee the subsidization effort and 	by
private individuals who incur costs in their effort to qualify for subsidized
rates. 	We 	also 	ignore 	the 	increase in social 	losses in 	other markets which
may occur when prices already exceed social costs in these markets.
Our analysis employs a number of simplifying assumptions to make the
analysis possible. 	For expositional simplicity these assumptions are phrased
in 	terms 	of 	third-class 	mail 	only; 	the 	same 	assumptions 	are 	made 	for
second-class mail as well. 	These assumptions are:
1. 	The 	current 	prices 	for 	non-preferred 	third-class 	mail 	are 	set 	at 	the
marginal cost of providing these postal services.
2. 	The demand for third class-mail by preferred classes reflects the social
value of their use of the mail.
3. 	The 	demand 	curve 	of 	preferred 	mailers 	for 	third-class 	mail 	is
approximately linear in 	the region 	between 	the regular price and 	the price
for preferred mailers.
4. 	The 	marginal 	cost 	curve 	for 	providing 	third-class 	mail 	to 	preferred
mailers is approximately linear and flat in the region between the quantities
demanded at the regular price and the price for preferred mailers.
5. 	There are 	no 	other distortions in 	the economy which 	cause 	the prices
of other goods to diverge from their social costs.
6. 	There are no secondary effects due to the interaction of various types
of mail.
Under the six assumptions, the deadweight loss due to the subsidization

of 	second 	or 	third 	class 	mail 	can 	be 	approximated 	using 	the 	following
formula: 1
Loss • [(dP)(dQ)]/2
In this formula dP is the reduction in price granted to preferred classes of
mailers 	and 	dQ 	is 	the 	increase 	in 	the 	quantity 	of 	second 	or 	third 	class
postal services that results from the reduction in price.
Annual 	deadweight 	losses 	due 	to 	subsidization 	will 	be 	estimated 	for
three 	different 	levels 	of subsidization 	which 	were 	present 	during 	the 	last
twelve 	months. 	Before January 	1986, preferred mail prices were set below
attributable 	costs. 2 	In 	January, 	these 	prices 	were 	raised 	so 	that 	revenues
covered 	expected 	attributable 	costs. s 	On 	March 	9, 	1986, 	preferred 	mail
prices 	were 	raised 	above 	attributable 	cost 	levels, 	although 	preferred 	mail
rates are still below regular mail rates."
Deadweight Loss Due To Subsidization
Of Third-Class Mail
To apply the loss formula 	to estimate the deadweight loss that results
from 	the 	subsidization 	of 	certain 	types of 	third-class 	mail, 	we 	must 	know
the change in price and change in quantity that will result when 	the price
charged 	preferred 	third-class mailers is reduced 	from 	the "regular" price to
the 	"preferred" 	price. 	Using 	estimates 	of 	the 	elasticity 	of 	demand 	for
third-class preferred 	mail (e) and 	sales of third-class mail (q) at subsidized
prices 	(p), 	it 	is 	possible 	to 	estimate 	sales 	(q.) 	at 	the 	regular 	prices 	(p.).5
This 	calculation 	relies 	on 	the 	definition 	of 	the 	elasticity 	of 	demand.
Because 	the elasticity of demand (e) equals (dQ/dP)(p/q), dQ equals (q-q.),
and 	dP equals (p-p.), 	it 	is true 	that 	q. equals -(q){[(e)(dP /p)]-l}. 	Once 	we
know 	q., we can calculate the change in quantity (dQ) which 	is associated
with the change in price (dP).
1 This formula 	is derived in F.M Scherer, Industrial 	Market Structure
and Economic Performance, First Edition, (Chicago: Rand McNally, 1970):400-
404.
2 Prices were set at "Step 14" levels. The price, quantity, and elasticity
of demand for this period will be given by p, q, and e.
S These 	prices 	are 	known 	as Step 	16 	prices. 	The 	price, 	quantity, 	and
elasticity for this period will be identified by p.", q ••• , and e···.
" Variables 	associated 	with 	regular 	rates 	are 	indicated 	by 	a 	single 	•
Current rates are indicated by two ··s.
5 Along 	a 	linear 	demand 	curve, 	the 	elasticity 	will 	rise (become 	more
elastic) as price increases from 	p to p•. As a result, the elasticity e· at p.
will not equal the elasticity e at p.
2

The values we input into this expression were obtained from the Postal
Rate 	Commission. 	Specifically, 	the 	values 	for 	p*, 	p and 	Q were obtained
from a PRC table which reports the revenues and volume of third-class mail
during 	the 	first 	Quarter 	of 	the 	current fiscal 	year. 6 	The value of e was
derived from the testimony of George Tolley in PRC Docket No. R84-1. 7
The data used in the analysis are given in the following table:
6 	This 	table 	is 	entitled 	"Revenue, 	Pieces 	and 	Weight 	by 	Classes 	of
Mail 	and 	Special 	Services 	for 	Postal 	Quarter 	I 	of 	Fiscal 	Year 	]986
(September 	28, 	] 985 	- 	Dec 	20, 	]985) 	Compared 	with 	the 	Corresponding
Quarter of Fiscal Year ]985" Subsequently, it will be referred to as the First
Quarter Revenue Table.
Price per piece was assumed to equal revenue divided by the number of
pieces. The resulting prices reflect the subsidized Step 	]4 rates which were
charged before the movement to Step ]6 rates in January, ]986.
7 	Based 	on 	pre-] 982 	data, 	Tolley 	estimates 	that 	the 	elasticity 	of
demand for non-profit bulk mail is -.074. 	We adjusted this value upward to
-.2 when setting the value of e for two reasons: (l) If demand is linear, as
is 	assumed 	in 	this 	analysis, 	demand 	will 	be 	more 	elastic 	at 	higher 	price
levels. Since prices have increased since Tolley made his estimate, we would
expect demand to be more elastic at current prices than it was at the lower
prices 	which 	prevailed 	during Tolley's sample 	period. 	(2) 	We 	believe 	that
Tolley's original estimate is 	biased downward, since 	his regression equation
does 	not 	include 	a 	variable 	to 	control 	for 	the 	growth 	of 	non-profit
organizations. 	Since non-profit organizations have been growing in number
while 	third-class 	preferred 	mail 	prices 	have 	been 	increasing, 	one 	would
expect that the reduction in non-profit mail volume resulting from the price
increases will 	be offset to same extent by an increase in volume due to the
presence of 	more 	potential customers. 	Since Tolley 	doesn't control 	for 	the
effect 	that the 	growth in the number of non-profit organizations will 	have
on volume, he understates the quantity depressing effect price increases will
have, and thus underestimates the elasticity of demand.
We believe our upward adjustment in Tolley's estimate is conservative.
Our approach 	is equivalent to assuming an elasticity of -.58 at p*. Tolley's
estimate of the elasticity of demand for non preferred mailers at p* is -.935.
Thus, our 	approach 	produces a 	much 	lower elasticity 	for 	preferred mailers
than 	would 	the 	assumption 	that 	the 	elasticities 	for 	the 	two 	types 	of
third-class 	mail 	are 	the 	same 	at 	this 	price. 	This 	makes 	the 	approach
conservative, 	since 	the 	lower 	the 	as.sumed 	elasticity 	at 	p* 	the 	smaller 	the
deadweight loss estimate.
3

Data For Third-Class
Preferred Mail Loss Calculation
e
p
p*
q
q*
dP
dQ
-.2
S.05/piece
S.II/piece
11.00 billion pieces
8.36 billion pieces
-.06/piece
2.64 billion pieces
Substituting 	the 	estimates 	for 	dP 	and 	dQ 	into 	the expression 	for 	the
deadweight 	loss 	gives 	an 	approximate 	loss 	of 	$79.2 	million 	for 	third-class
mail. 	However, 	this 	is 	the deadweight 	loss 	that 	was 	occurring 	before 	both
the January and March price increases for preferred mail.
Between January and 	March, when Step 	16 prices were 	in effect, the
subsidy was around $.04. This caused output to be 1.76 million pieces higher
than it would have been at unsubsidized levels. 8 	The associated estimate of
the dead weigh t loss is $35.2 million.
Currently, 	the 	subsidy 	is 	nearer $.03.9 	This reduction 	in 	the subsidy
reduces 	dP 	to 	$.03/piece 	and 	dQ 	to 	1.32 	billion 	pieces. lO 	The 	associated
deadweight loss falls to $19.8 million.
8 Volume figures given 	in 	the First Quarter Revenue Table were used
to 	weight 	Step 	16 	prices 	(as 	reported 	in 	"Statement 	of 	Chairman 	John 	R.
McKean on Preferred Rates of Postage," February 4, 1986--hereafter McKean
Statement). 	The 	average 	price 	we 	obtained 	was $.07. The 	quantity 	(q**.)
and change in quantity (q*.*-q*) were obtained using the same procedure as
was used to obtain q* and (q-q*).
9 	The figure of $.03 was obtained by comparing the weighted minimum
prices 	for 	third-class 	non-profit 	mail 	given 	in 	Schedule 	5 	of 	McKean's
Statement 	to 	the 	average 	prices 	charged 	regular 	third-class 	mailers 	which
were 	calculated 	from 	the PRC First Quarter 	Revenue and 	Table 	using 	the
1986 figures in that 	table. The 	weights which 	were used 	in calculating the
1986 	third-class 	preferred 	price 	were 	obtained 	from 	the 	third-class 	volume
figures reported in PRC First Quarter Revenue Table.
10 The 	quantity 	q*. 	and 	the 	change 	in 	quantity 	(q ••q •• ) due 	to 	the
current subsidy were derived using the same procedure as was used to obtain
q* and (q-q.).
4

Deadweight Loss Due To Subsidization
Of Some Second-Class Mail
Estimation 	of 	the 	deadweight 	loss 	which 	may 	result 	from 	the
subsidization 	of 	second-class 	mail 	is 	more 	difficult, 	since 	the 	pricing 	of
second-class 	mail 	is 	more 	complicated 	than 	third-class 	mail 	pricingll 	and
weighted 	average 	prices 	for 	the 	relevant 	quantities 	were 	not 	available.
Nonetheless, 	we 	derive 	an 	estimate 	by 	assuming 	that 	the 	"illustrative"
examples 	of 	second-class 	mail 	suggested 	in 	McKean's 	Statement 	have 	the
average 	characteristics 	of 	in-county 	and 	non-profit 	mail. 	Using 	these
characteristics 	and 	rate 	schedules 	for 	the 	three 	different 	time 	periods, 	it
was possible to obtain estimates of p, p •• , and p •••. 12 	An estimate of the
current 	average 	price 	for 	regular 	mail 	(p.) 	was 	calculated 	from 	the 	PRC
First Quarter 	Revenue 	Table. Is 	The 	prices we obtained 	in 	this way align
with other PRC figures. 14
The 	analysis 	also 	requires 	us 	to 	estimate 	the 	volume 	of 	second-class
preferred mail (q) which was sent at the subsidized prices which prevailed
before January 1986 and the elasticity of demand (e·) at regular prices. 	The
volume at p was assumed to be 3.5 million 	pieces a year, which is 35% of
11 	Unlike 	third-class 	mail, 	all 	second-class 	mail 	has 	both 	a 	per 	piece
charge 	and 	a 	charge 	based 	on 	the 	weight 	of 	the 	item. 	As 	a 	result, 	the
average 	price depends on 	the characteristics of the newspaper or magazine
which is being mailed and will, as a result, vary siginificantly.
12 	The 	in-county 	and 	non-profit 	mail 	were 	averaged 	using 	weights
derived 	from 	Table 	1 	in 	Tolley's 	testimony 	in 	PRC 	Docket 	No. 	R84·1.
Specifically, in-county mail was assumed to be 40% of preferred second-class
mail 	before 	March 	9, 	1986. 	Because 	of 	changes 	in 	eligibilty 	requirements,
which now prevent national publishers from using in-county mail, this figure
was reduced to 20% after March 9, 1986.
13 This calculation 	assumed 	that p equaled $.055, 	that 	35% of second-
class mail 	is preferred mail, and that the average price of mail during the
first 	quarter 	of 	the 	current 	fiscal 	year 	was 	$106. 	The 	$.055 	came, 	as 	is
explained 	in 	the 	text, 	from 	the 	"illustrative" 	examples 	in 	McKean's
Statement. The 35% figure was derived from Table I in Tolley's testimony in
PRC 	Docket No. R84-1. 	And 	the average price of mail ($.106) was derived
from the PRC First Quarter Rate Table by deviding revenues by total pieces.
14 For example, using the description of the illustrative example which
was 	used 	to calculate 	the 	non-profit 	mail 	rate which 	is given 	in 	the table
"Description of Illustrative Preferred Rate Example" and the pricing formula
given 	in 	Rate 	Schedule 	301 	in 	Appendix 	One, 	Opinion 	and 	Recommended
Decision, Docket No. R84-1, we calculated that the price for similar regular
non-profit mail would be $.13. This suggests a level of subsidization of $.06,
as we initially assumed.
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the roughly 	10 million pieces of second-class mail which is sent each year. 1S
The 	elasticity 	e* 	was 	assumed 	to 	be -.40 	at 	p*. 	This 	aligns 	roughly 	with
Tolley's estimates used in PRC Docket No. R84-1. 16
With this data, we were able to obtain all of the values we needed to
calculate 	the deadweight 	10ssP 	The data 	we 	used 	are summarized 	in 	the
following table:
Data For Second-Class
Preferred Mail Loss Calculation
e*
p
p*
p**
p***
q
q*
-.40
$.055jpiece
$.133jpiece
$.085jpiece
$.074jpiece
3.50 billion pieces
2.835 billion pieces
15 	The 	PRC 	First 	Quarter 	Revenue 	Table 	indicates 	that 	2.5 	million
pieces 	of 	second-class 	mail 	were 	sent 	in 	the 	first 	quarter 	of 	1986, 	which
would 	produce a 	yearly volume of 	10 million 	pieces if subsequent quarters
were the same. Data 	from earlier years indicate that preferred second-class
mail 	is 	roughly 	35% of all 	second-class 	mail. 	For 	example, see Table 	1 in
Tolley's testimony in PRC Docket No. R84-1.
16 	Tolley 	estimated 	that 	the 	elasticity 	of 	demand 	for 	non-profit
second-class mail was -.29 and 	the elasticity for 	in-county second-class mail
was 	-.395. 	These 	estimates 	will 	understate 	the 	elasticity 	at 	p* 	for 	the
reasons discussed in 	footnote 7. As a result, we rounded off Tolley's higher
estimate and used it.
17 In 	the calculation 	of deadweight 	loss 	for 	third-class 	mail 	we 	noted
q* equals -(q){[(e)(dPjp)]-I). Since we know e* and 	not e, we must derive a
different 	equation 	to 	calculate q* 	in 	the 	case 	of second-class 	mail. 	To do
this 	one 	again 	starts 	with 	the 	definition 	of 	the elasiticity of 	demand, 	but
one 	uses the formula 	for 	the elasticity at p* rather than at p. Specifically,
one defines e* as:
(dQjdP)(p* /q*)
Using this definition, it can be shown that
q* = (q)/{[(dP /p*)(e*)]-I)
From 	this 	equation, 	it 	is 	possible 	to calculate 	the 	value 	of q* reported 	in
the table. Given this value of q*, it is possible to then calculate dQ.
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Substituting the values for 	dP and dQ before the January 	1986 price
increase 	into 	the 	deadweight 	loss 	formula, 	we 	obtain 	an 	estimated annual
deadweight 	loss 	of 	$25.9 	million 	due 	to 	the 	$.078 	subsidization 	of
second-class 	mail 	and 	an 	increase 	in 	sales 	of 	.665 	billion 	pieces. 	The
January price increase which is estimated to have cut dP to $.059 and dQ to
.503 	million 	appears 	to 	have 	reduced 	the 	annual 	deadweight 	loss 	to $14.8
million. 	The 	recent 	March 	9, 	1986 	price 	increase 	is 	estimated 	to 	have
reduced 	the annual 	deadweight loss to $9.8 	million, 	by reducing dQ to .41
million and dP to $.048.
Sensitivity Analysis
The 	results 	are 	particularly 	sensitive 	to 	the 	size 	of 	dP. 	As 	the
empirical examples discussed above indicate, doubling dP leads to more than
a doubling in the deadweight loss. Thus, it is important to understand what
affects the size of dP.
The dP term reflects the difference between the marginal cost and the
marginal 	benefit 	of 	mail 	services 	at 	the 	Quantity 	demanded 	by 	preferred
mailers in response to the preferred price. 	If the marginal cost of providing
these services 	is higher 	(or 	lower) 	than 	the 	value given in assumption (1),
then 	the 	deadweight 	loss 	will 	be 	higher 	(or 	lower). 	Similarly, 	if 	the
marginal social value of mail for preferred classes is higher (or lower) than
the 	amount preferred classes are 	willing to pay at the margin (namely the
preferred 	price), 	then 	the 	deadweight 	loss 	will 	be 	lower 	(or 	higher). 	For
example, 	if 	the 	output 	of 	non-profit 	organizations 	is 	considered 	to 	be 	a
public 	good, 	one 	might 	argue 	that 	the 	social 	value 	of 	extra 	mailing 	by
non-profit firms is greater than they are willing to pay. 	On the other hand,
the 	willingness of non-profit firms 	to pay for 	mail is already increased by
the 	sizeable 	subsidies 	granted 	to 	non-profit 	institutions 	through 	the 	tax
system, 	so one 	might 	argue 	that 	the social 	value 	of additional 	mailings 	is
actually less than their willingness to pay.
The 	estimate of 	the deadweight loss is also sensitive to the estimated
elasticity of demand of preferred mailers at the unsubsidized price. 	A larger
elasticity would lead to greater estimated losses and a lower elasticity would
lead 	to lower estimated losses, for a given dP. 	The reason for 	this is that
when demand is elastic (inelastic) the change in output which results from a
change 	in 	price 	is 	larger 	(smaller), 	and 	it 	is 	this 	change 	in 	output 	which
leads to the redistribution of resources.
7