The International Handbook of Telecommunications Economics, Volume II
Edited by Gary Madden
Chapter 10: Regulated costs and prices in telecommunications
Jerry A. Hausman INTRODUCTION Economic advice to regulators regarding the correct principles to set regulated prices has often been ﬂawed in that it does not recognize the underlying technology of the industry. Economists recognized early on that in the situation of privately owned utilities in the United States (US) the ﬁrst-best prescription of price set equal to marginal cost could not be used because of the substantial ﬁxed (and common) costs that most regulated utilities needed to pay (see Kahn, 1970). This realization typically accompanied the claim that the economies of scale of the regulated ﬁrm were so signiﬁcant that competition could not take place because the regulated ﬁrm’s cost function was signiﬁcantly below that of new entrants. Nevertheless, the most common advice from economists was that prices should be set similar to the outcome of a competitive process. What the competitive process would be was never speciﬁed in any detail, which was to be expected since economic theory had no well-accepted model of competition with a technology exhibiting strong economies of scale, especially in the multi-product situation. In the US, regulators following legal principles adopted the position that the regulated ﬁrm should cover its costs. However, regulators also adopted prices for certain services to attempt to meet social goals for these given services. For other services, regulators used arbitrary means to set prices while balancing competing claims from increasingly well organized groups of consumers, all of whom claimed they should receive low prices with other groups...
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