Regulatory Bias in the Price Structure of Local Telephone Services

Abstract

This paper combines a discrete choice model of demand for residential local telephone service and a model of optimal price regulation to estimate the welfare weights that state regulators place on consumers with di¤erent incomes and locations. The methods employed allow for endogenous prices and use simulation to control for household-level di¤erences in income and participation in subsidy programs. The results show that, while state regulators place a larger relative weight on low income consumers in rural areas, there is no evidence for a bias towards rural consumers on average. I also …nd that the relative weight on low income consumers is lower in poor areas, and that it is larger if the regulator is a Democrat or subject to direct election. I explore the welfare e¤ects of replacing the observed price structure with (i) prices equal to marginal or average costs, (ii) prices that maximize unweighted consumer surplus and (iii) prices that recover the total cost of residential service. These alternative policies generally lead to reductions in telephone penetration among low income consumers, substantial redistribution of surplus from consumers to …rms and fairly small increases in total welfare. The welfare gains are somewhat larger if geographic price discrimination is allowed.