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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 2: Cost function issues and estimation

Yale M. Braunstein and Grant Coble-Neal


Yale M. Braunstein and Grant Coble-Neal INTRODUCTION Since the ratification in 1997 of the World Trade Organization agreement on basic telephone services, more than 1000 facilities-based international carriers have become operational in a global market (TeleGeography, 1999). The response from large carriers is to establish global service platforms by horizontal and vertical integration, and a changing web of international alliances (Braunstein et al., 1999). These changes have resulted from fundamental shifts in regulatory environment and the presence of economies of scale and scope. The bundling of voice, data and video services provides substantial scope for innovation and cost saving. However, horizontal and vertical integration has seen a reduction of competition in global markets. United States (US) and European Union regulators have permitted mergers in the belief that larger scale in telecommunications is in the public interest. Clearly, reliable estimate of telecommunications carrier cost structures is essential for decision-making. Much recent research builds on studies of telecommunication costs published in the 1960s and 1970s.1 Development in the estimation of production technology follows from the work of Arrow et al. (1961) and Nerlove (1963) that relax restrictive factor substitution and returns to scale assumptions implied by Cobb–Douglas technology. Early-1970s developments include duality theory by Diewert (1971) and the use of flexible functional forms by Diewert (1971) and Christensen et al. (1971). The subsequent development of economies of scope by Panzar and Willig (1975) and the notion of subadditivity by Baumol (1977) provided further impetus to applied research. Typical applied studies...

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