Economic logic for market structures, profits/losses and pricing are explored in this essay through examining Australia Post’s letter delivery service.
Q1)
Australia Postal Corporation (Australian Post) is an Australian government-owned entity; their “reserved right” – to exclusively deliver standard letters domestically (by Australian Postal Corporations Act 1989) – creates a legal barrier to entry, forbidding other firms to enter letter delivery market (Australian Competition and Consumer Commission, 2016, “Assessing cross-subsidy in Australia Post”, p. 3), which implies that the market is a statutory monopoly.
Since Australia Post is the letter delivery market’s only supplier (Australia Post, 2016a), while there are many buyers, they are the market’s price maker.
Australia Post possesses market power, since they face a downward-sloping (due to diminishing marginal benefit) market demand curve, they can raise price without losing all customers.
Profit-maximizing quantity (Qm) is determined at MR = MC (profit is maximum when selling up to a point where extra units sold would decreases profit). Demand curve at this quantity gives the profit-maximizing price (Pm).
Figure 1.1
However, since Australia Post is government-owned and pricing is reviewed by ACCC, price may not be set to maximize profit but to reduce deadweight losses (DWL) or improve social/consumer welfare. Despite this, the assumption of MR = MC is used for simplicity (price of regular mail set at $0.70AUD in 2015 (Australia Post Newsroom, 2015).).
Market for standard letters delivery is also a natural monopoly: since marginal costs are relatively low and fixed/start-up costs are large (logistics/offices/recruitment/transportation), one firm can supply the entire market at a cost lower than two (or more) firms.
Characteristics identified are consistent with those of statutory
and natural monopoly (Nguyen et al., 2016, p. 105).
Q2)
Australia Post incurred an accounting loss of AUD$381 million (before tax and interest) in 2014-2015 financial year (Australia Post, 2015, p. 72). This is caused by increase in demand for substitute product – electronic communication services (social media messaging/SMS/email: cheaper, faster delivery) (McCauley, 2016) – which has two effects:
Decrease in demand for standard letters: substitutes are consumed as replacements of one another; increase in quantity of substitutes traded decreases quantity traded in standard letter market. This results in a leftward shift of market demand curve (MB0 to MB1) and MR in Figure 2.2. (In 2015, one billion fewer standard letters were delivered than 2008 (Griffiths, 2015).)
Increase elasticity of market demand curve, as consumers are more sensitive to price fluctuations, increasing price would lose customers to substitutes. This causes gradient of MB and MR curve to decrease (i.e. MB1 “flatter” than MB0).
(Assume MC curve is upwards-sloping and linear for graphical simplicity)
(Assume MC and ATC remains the same: ceteris paribus)
Market for letter delivery (pre-2015) (Figure 2.1)
Market for letter delivery (2015) (Figure 2.2)
Both factors decrease market price and quantity (shown in Figure 2.2: P0 to P1 and Q0 to Q1); since TR = P*Q, total revenue will decrease. Consequently, economic profit (TR – TC) decreases from positive profit (area A0 Figure 2.1), to negative profit (loss) (area A1 Figure 2.2). Losses are incurred (Figure 2.2) since the Average Total Cost at quantity traded is greater than market price (p = Q(P – ATC)) (Nguyen et al., 2016, p. 109).
Q3)
From 4th/January/2016, a variety of delivery speeds and prices were introduced:
- Express ($5.75): delivered next business day
- Priority ($1.50): delivered 1 - 4 business days
- Regular ($1): delivered 1 - 6 business days (Australia Post, 2016b).
Australia Post practices second-degree price discrimination. Consumers have different willingness to pay (WTP), but distinctions are unobservable to monopolist. Each consumer self-selects the type of service based on their own WTP/valuation of each version (consumers with higher WTP could choose higher-priced service)
Benefits
Consumers with valuation lower than price of service (consumer “A” valuates Regular at $0.5) would still trade if their valuation for another version exceeds its price (“A” valuates Express at $10). Therefore, forgone trades under single-price monopoly can now occur. Thus, increases consumer surplus without compromising Australia Post’s producer surplus, and increases total profit. Previously, the single-price monopoly did not operate at an efficient level and converted some CS to PS, resulting in DWL.
Additionally, compared to first and third-degree price discrimination, less information needed regarding consumers’ WTP and minimal arbitrage requirements (self-selection: no resell advantages).
The success of Australia Post’s second-degree price discrimination is shown in the decrease of accounting loss from AUD$381million in 2014/15 to AUD$138million in 2015/16. (Australia Post, 2016c, p. 12)
Conclusion
Australia Post are introducing pricing strategies to raise revenue and combat losses. However, if demand for electronic communication continues to grow, Australia Post would either require massive cross-subsidy, privatization or abandonment.
References (139)
Australian Competition and Consumer Commission (2016). Assessing cross-subsidy in Australia Post 2014-15. Retrieved from https://www.accc.gov.au/publications/assessing-cross-subsidy-in-australia-post/assessing-cross-subsidy-in-australia-post-2014-15
Australia Post. (2015). Australia Post Annual Report 2015. Retrieved from http://auspost.com.au/annualreport2015/docs/australia-post-annual-report-2015.pdf
Australia Post (2016a). Fast facts about Australia Post. Retrieved 15 May, 2017 from https://auspost.com.au/about-us/news-media/fast-facts-about-australia-post
Australia Post. (2016b, January 3). Guide to the new letters service [Video file]. Retrieved from https://www.youtube.com/watch?v=OWA20FJlv00
Australia Post. (2016c). Australia Post Annual Report 2016. Retrieved from http://auspost.com.au/annualreport2016/resources/docs/auspost_financial_report.pdf
Australia Post Newsroom (2015). Price Changes 2016. Retrieved 17 May, 2017 from https://auspost.newsroom.com.au/Content/Default/02-News/Article/Pricing-changes-effective-4-January-2016/-3/2/6072
Griffiths, E. (2015, March 3). 70 cents stamps could cost $1 under plan for Australia Post. ABC News. Retrieved from http://www.abc.net.au/news/2015-03-03/70c-stamps-could-cost-$1-under-plan-for-australia-post/6276704
McCauley, D. (2016, Aug 26). Australia Post results 2016: Profit of $36m, but $1.5m loss ahead as letters decline. Retrieved from http://www.news.com.au/finance/business/retail/australia-posts-amazing-35-billion-turnaround/news-story/395ed86e15197c2be151e232cab6378b
Nguyen, B. " Wait, A. (2016). Essentials of Microeconomics. London, UK: Taylor " Francis
