Regulating an Input Monopolist with Minimal Information: The Local Cap

Abstract

The uses minimal information to establish an optimal price for a monopolized input in a vertically integrated firm. Under it only upstream costs need be known. No demand information is required. It is comparatively welfare efficient and has a small regulatory footprint. Profits are capped upstream (e.g., in local telecommunications) and unregulated competition enabled downstream (e.g., long distance telephony). The input (interconnection) price is set by the monopolist rather than the regulator, subject to it being less than the monopolist's downstream price and to a simple cap: at most, upstream retail (local call) and interconnection revenues (including fees imputed to the monopolist for its downstream services) cannot exceed upstream (local transport) costs taking account of social programs imposed on the incumbent. The local cap is compatible with upstream regulation including universal service obligations, guarantees access deficit coverage by an efficient provider, and may be implemented as a price cap or cost-of-service-approach. Using Australian data, it is estimated that the local cap could have halved Australian long distance prices in 1989.