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Emerging Telecommunications Networks

The International Handbook of Telecommunications Economics, Volume II

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 10: Regulated costs and prices in telecommunications

Jerry A. Hausman


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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