Cross-subsidization in the telephone industry: Empirical evidence from the pre-divestiture era

Abstract

A cost function for local exchange companies (LECs) is estimated using 1980 data for 37 LECs operating in the state of New York, with, as outputs, the annual numbers of local and toll calls. The computation of the 1980 price/marginal cost ratios for local and toll services suggests that, for many of these LECs. toll service did indeed subsidize local service prior to the divestiture of the Bell System in 1984. and that the larger the shares of toll calls and business users, the stronger the extent of this cross-subsidization. Quasi-optimal Rumsey prices are computed under a range of feasible price elasticities of demand for local and toll calls. Ramsey pricing would lead to a total net increase in consumer surplus ranging from $5 million to $21 million, representing the balance between significant losses for local users and significant gains for loll users. While the results provide overall support for the shifts in cost burden from toll to local service, which have taken place during the 1980s, they also suggest that these shifts may have been inappropriate for rural exchanges with few toll calls and few business users. In these exchanges, local service may now be subsidizing toll service to a much larger extent than in the past.