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Traditional Telecommunications Networks

The International Handbook of Telecommunications Economics, Volume I

Edited by Gary Madden

This major reference work provides a thorough and up-to-date survey and analysis of recent developments in the economics of telecommunications. The Handbook serves both as a source of reference and technical supplement for the field of telecommunications economics.
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Chapter 1: On the subadditivity of cost functions

Russel J. Cooper, W. Erwin Diewert and Terence J. Wales


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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