Ramsey Pricing as a Method to Financing the Universal Service Obligation

The postal market today is characterized by a change in emphasis from delivery of written items to delivery of parcels. When volumes shift from previously monopolized markets to more competitive areas, concerns grow about how to maintain and finance the universal service obligation (USO). The price elasticity of demand for different postal products varies. To generate sufficient revenues to meet the overall budget target while minimizing welfare losses, regulators may employ Ramsey pricing: that the relative difference between price and marginal cost should be inversely proportional to the price elasticity of each product. The quantity for each product with marginal cost pricing and linear demand will be k% higher than the sales of that product under Ramsey pricing. The required markup over marginal cost for each product relative to the elasticity of demand to cover costs depends on the economies of scale, the average price elasticity, and the differences in price elasticity of the goods in question. In this chapter, we show how Ramsey pricing can be applied, and its effects on profitability and welfare with numbers from Sweden. We compare the benefits of this type of pricing to other alternatives as a compensation fund or a subsidy. Regardless of which methods of financing are used, some forms of regulated prices based on Ramsey pricing are beneficial from both welfare and financing points of view. In the postal industry, applying Ramsey pricing can contribute to the financing of the USO, seen as a common cost, and at least prolong the time before other types of financing are needed while minimizing welfare losses. To achieve the benefits, adjustments in regulation may be needed, such as promoting long-run cost adjustments, removing too strict price-caps, and requiring that each single product covers only its own costs.