Exercise: Postal Service

Part 1: A Pay Raise for Postal Workers

Step 1. Draw a demand and supply model to illustrate what the market for the U.S. Postal Service looks like before this scenario starts. The demand curve D and the supply curve S show the original relationships.

Figure 2. The supply and demand curves for the U.S. Postal Service after a pay raise for postal workers.

Step 2. Will a pay raise for postal workers affect supply or demand?

Step 3. Is the effect on supply positive or negative?

Step 4. Compare the new equilibrium price and quantity to the original equilibrium price.

A pay raise for postal workers would represent an increase in the cost of production for the Postal Service. Production costs are a factor that influences supply; thus, the pay raise should decrease the supply of first-class mail, shifting the supply curve vertically by the amount of the pay raise. Intuitively, all else held constant, the Postal Service would like to charge a higher price that incorporates the higher cost of production. That is not to say that the higher price will stick. From the graph (Figure 1), it should be clear that at that higher price, the quantity supplied is greater than the quantity demanded—thus, there would be a surplus, indicating that the price the Postal Service desires is not an equilibrium price. Or, to put it differently, at the original price (P₁), the decrease in supply causes a shortage, driving up the price to a new equilibrium price (P₂). Note that the price doesn’t rise by the full amount of the pay increase. In short, a leftward shift in the supply curve causes a movement up the demand curve, resulting in a lower equilibrium quantity (Q₂) and a higher equilibrium price (P₂).

Part 2: The Effect of Email and Text Messaging

Step 1. We’ve already seen how a pay raise will shift the supply curve to the left. Now let’s consider how the invention of email and text messaging affects the market for first-class mail. Begin by drawing a demand and supply model reflecting this relationship.

Figure 3. The impact of email and text messages on the snail mail market.

Step 2. Does email and text messaging affect supply or demand?

Step 3. Is the effect on demand positive or negative?

Step 4. Compare the new equilibrium price and quantity to the original equilibrium price.

To summarize, since many people find email and texting more convenient than sending a letter, we can assume that tastes and preferences for first-class mail will decline. This decrease in demand is shown by a leftward shift in the demand curve and a movement along the supply curve, which creates a surplus in first-class mail at the original price (shown as P₂). The shortage causes a decrease in the equilibrium price (to P₃) and a decrease in the equilibrium quantity (to Q₃). Intuitively, less demand for first-class mail leads to a lower equilibrium quantity and (ceteris paribus) a lower equilibrium price.

Part 3: Combining Factors

Parts 1 and 2 are straightforward, but when we put them together, it becomes more complex. Think about it this way: in Part 1, the equilibrium quantity fell due to decreased supply. In Part 2, the equilibrium quantity also fell, this time due to the decreased demand. So putting the two parts together, we would expect to see the final equilibrium quantity (Q₃) to be smaller than the original equilibrium quantity (Q₁). So far, so good.

Now consider what happens to the price. In Part 1, the equilibrium price increased due to the reduction in supply. But in Part 2, the equilibrium price decreased due to the decrease in demand! What will happen to the equilibrium price? The net effect on price can’t be determined without knowing which curve shifts more, demand or supply. The equilibrium price could increase, decrease, or stay the same. You just can’t tell from graphical analysis alone. This is not unusual. When both curves shift, typically we can determine the overall effect on price or on quantity, but not on both. In this case, we determined the overall effect on the equilibrium quantity, but not on the equilibrium price.

Figure 4. Decreased supply and decreased demand cause the equilibrium quantity to fall (Q₃ is smaller than the original equilibrium quantity of Q₁). It is hard to pinpoint what happens to the price, however, as it may decline with the shrinking demand, but also increase with production costs.