Question

Explain how you would calculate the economic value created by the USPS, taking into account the positive externalities it produces.

Here's a few comments: The USPS has had $45 billion or so in cumulative accounting losses over the past four decades or so (see its financials). Was what the USPS produced over the past four decades worth $45 billion to the taxpayers? Take a for-profit business like FedEx. We know the value of the company’s inputs; that’s easy, we can look at their expenses. Now, what is the value of what they produced? Let’s assume for a second that what they produced is a private good with no externalities. Let’s also assume that the value of its services to customers matched or exceeded the amount its customers paid for its services. This is a reasonable assumption, because if it weren’t the case, customers wouldn’t voluntarily engage in transactions with the company. So, what is the value of what FedEx produced? In this case, it would be its revenue plus the difference between what customers paid for Fedex’s services and the value they placed on those services. This difference is called consumer surplus. So the value of what FedEx produced in a given year would be its revenue plus the consumer surplus it generated. To see if they created any economic value, you would subtract expenses from this total.

Bonus questions: Where does profit enter this equation? Note the following: (Revenue + Consumer Surplus) - Expenses = (Revenue - Expenses) + Consumer Surplus = Profit/Loss + Consumer Surplus = Economic Value Created. Why isn't profit/loss, by itself, enough to determine if economic value has been created? Why isn't profit/loss enough to determine if an organization is "efficient" or not?

For example, assuming that everything stays the same with respect to its operations and its volume of business, how FedEx prices its goods and services doesn’t change the amount of economic value it creates. If FedEx raises its prices (and its volume of business stays the same), it may increase its profits, but it would reduce consumer surplus by the same amount, so it would be a wash. What if FedEx lowered its prices below its costs? It would lose money, but the decline in revenue would be offset by a corresponding increase in consumer surplus, so the economic value created by the company would, again, remain the same. In this example, assuming the volume of business stays the same, FedEx’s pricing decisions affect the allocation of value—i.e. how the value created by the company is split between itself and its customers—but it doesn’t effect the overall amount of value the company creates.

The USPS doesn’t produce a private good, like we assumed in the case of FedEx. What it produces is a merit good, defined as a good or service that has both private benefit and associated positive externalities. This adds another layer of complexity to a strategic assessment of the USPS.

Answer 1

For strategic assessment of the USPS we need to split costs between private costs and external costs.

Similarly benefits between private benefit and external benefit.

Social cost= Private cost + External cost

Social benefit = Private benefit + external benefits

USPS is a company that produces is a merit good, defined as a good or service that has both private benefit and associated positive externalities.

Let us say, USPS invests $10 milion in a year, this is its private cost as it is borne by the company.

Now, the external cost can be anything negative produced due to company operations like pollution, environmental degradation etc. This cost is let us say $1 million.

Now, company gets a revenue of $ 8 million, this would be its private benefit as it goes to owner. However, due to production of merit good there is external benefit may be jobs generated or training given and hence improvement in the standard of living or help in environmental sustainability is $ 6 million.

In this case Social cost = $ 11 million but social benefit = $14 million.

Hence even if a company is having loss it is generating more social benefit ad hence should be protected.

Consumer surplus and is added to external benefit , producer surplus is added to private benefit.