The International Handbook of Telecommunications Economics, Volume I
Edited by Gary Madden
Chapter 1: On the subadditivity of cost functions
Russel J. Cooper, W. Erwin Diewert and Terence J. Wales INTRODUCTION In the last decades of the twentieth century, the concatenation of the technological revolution in info-communications with the increasing ﬁnancial capital mobility accompanying globalization led to some rethinking of the eﬃcacy of competition policy, especially in the context of key industries which are the subject of major technological innovation, which provide important infrastructure both to other industries and to the community generally, and which have developed structures containing signiﬁcant elements of monopoly provision and public provision of products and services. Since Baumol et al. (1982), it has become clear that in order to determine whether a multi-product regulated industry is a natural monopoly, it is helpful to estimate a multiple output cost function for the incumbent ﬁrm and then determine whether this estimated cost function is subadditive. Subadditivity may arise through economies of scale, economies of scope, or some combination of these. In the telecommunications area, the most important and inﬂuential studies that consider the subadditivity question in a multiple output setting are by Evans and Heckman (1983, 1984), who used data on the US Bell system. Evans and Heckman also pioneered an appropriate method for testing subadditivity in a multiple output setting. Diewert and Wales (1991) showed that the Evans and Heckman tests for subadditivity were ﬂawed. Their estimated translog cost functions were improper in that they contained features incompatible with microeconomic theory, invalidating their use for examining the issue at hand. In particular, they...
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