Ch 15 Rate Regulation And Universal Service

Ch. 15 – Rate Regulation and Universal Service
a. Rate Regulation
i. Rate of Return Regulation
1. Rates are based on the costs of the party that was regulated
2. If a regulated party shows higher costs, the regulator approves higher rates
a. The costs of a party is hard to regulate in that true information is tough to gain
b. It also leaves the regulated party with little incentive to economize expenses
c. Finally it encourages regulators to require long depreciation periods for physical investments which results in out of date equipment being used long after it has expired.
ii. Price Cap Regulation
1. An intitial maximum price is set with regards to likely costs, but after that the maximum price stays the same regardless of rising and falling costs.
2. Note that a price cap only works if the government commits to not changing the cap if the circumstances change.
3. A worry is that price caps cause firms to skimp on quality
a. Either you cut costs by becoming more efficient
b. Or you cut costs by reducing the level of service.
iii. Rate Regulation as Markets Become Competitive
1. Regulation often becomes acutely flawed when a market transitions to competition.
2. Prices are often raised relating to the huge investments required in infrastructure
a. However, regulted prices have a tendency to hover at this high level
b. This continues even as a market moves towards competition.
c. Prices set too low are also a problem in that they favor incumbents. Entry into a market is a costly procedure related to the infrastructure investment required
b. Universal Service
i. Origins
1. Easy to implement when Bell ran the entirety of the service
2. Pricing was easy in this system, b/c the cost of one service didn’t necessarily have to relate to its production. Costs could simply be shifted around.
3. This was easy to regulate when there was one system
a. Cross subsidies
b. Urban customers subsidized rural ones
ii. Ramsey Pricing
1. Universal Service Policies keep prices artificially high in order to keep other artificially low.
2. Equity and Efficiency are difficult to balance
3. This balance also relates to the cost of local and long distance services being balanced.
a. Prices can be set so that one is at marginal cost and the other is enough above so as to cover profit margins for both services. Or both can be raised, but this creates consumer struggles.
4. The Ramsey solution is that the price of both services so that they result in an equal reduction in demand (supply/demand economics)
a. Therefore if marginal pricing = 4,000 subscribers to local and 5,000 to long distance, then that 4:5 ratio should be adopted into the costs.
iii. Universal Service After Divestiture
1. Access charges were created and paid by long distance companies to local carriers for originating and terminating long distance calls.
2. Also fixed costs of the local network to the local rates through a subscriber line charge paid by local phone service customers.

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