Local Telephone Costs and the Design of Rate Structures

Abstract : A well-developed body of economic theory is available to guide the setting of prices for the multi-product regualated firm. Economic efficiency can be increased by designing rate structures that incorporate the basic principles developed from this theory. These principles call for provisionally pricing each of the firm's outputs at its marginal cost, testing to determine whether such rates satisfy a specified budget constraint (e.g., revenues = costs), and then suitably modifying the marginal-cost rates in order to satisfy the constraint. Most commonly, the trial rates produce insufficient revenue, and then rates must be raised according to the Ramsey rule--prices are increased above marginal costs in inverse proportion to the individual price elasticities of demand. This paper applies ratemaking theory to the design of rate structures for local telephone calls that efficiently rate the costs of the local network.