A model for studying the implications of price-cap regulation of local telephone services

Abstract

This paper presents a modeling approach to investigate the practical implications of price-caps for regulating local telephone prices. The model incorporates a stochastic customer choice component, a deterministic pricing component, and a price-cap regulatory component patterned after the Federal Communications Commission's price-cap model. Simulations illustrate the interplay among these components. The analysis is based on input data drawn from 3 months of actual local telephone usage for nearly 2000 households in Ohio. The hypothetical price-cap rule considered in the example is applied to a market basket consisting of the pricing elements for basic local residential telephone services. These price elements are for measured, message and flat rate local calling. The analyses show whether or not prices are currently at Ramsey prices, and how prices change if the telephone company seeks to maximize profits. The impact of the price changes on various demographic groups is presented. A graphic display shows the strength of the economic incentive for the company to operate more efficiently under the hypothetical price-cap rule.