CROSS-SUBSIDIZATION IN THE TELEPHONE INDUSTRY - EMPIRICAL-EVIDENCE FROM THE PRE-DIVESTITURE ERA

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 ou tputs, the annual numbers of local and toll calls. The computation of the 1980 price/marginal cost ratios for local and toll services sugges ts that, for many of these LECs, toll service did indeed subsidize loc al service prior to the divestiture of the Bell System in 1984, and th at the larger the shares of toll calls and business users, the stronge r the extent of this cross-subsidization. Quasi-optimal Ramsey prices are computed under a range of feasible price elasticities of demand fo r local and toll calls. Ramsey pricing would lead to a total net incre ase in consumer surplus ranging from $5 million to $21 million, repres enting the balance between significant losses for local users and sign ificant gains for toll users. While the results provide overall suppor t 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 f ew business users. In these exchanges, local service may now be subsid izing toll service to a much larger extent than in the past.