Regulated Prices with Competition and Heterogeneous Consumers

Abstract

This paper studies how the political influence of consumer groups and firms affects the behavior of state regulators and in turn the effectiveness of federal policies. We employ a unique granular data set for U.S. local telephone markets to examine empirically differences in state and intrastate characteristics that identify regulators’ pricing decisions with competition and heterogeneous consumers. Results show that state regulators take into account the overall structure of prices within a state when setting prices for a particular service in specific regions. We find that state regulators consider the direct and opportunity cost of service provision when setting prices, and follow a “share the pain” method of dealing with higher rural costs by increasing all prices across the state. In addition, they use federal universal service subsidies to reduce urban business prices rather than to reduce prices in the rural wire centers to which they are targeted. Removal of local entry barriers and incumbent line-of-business restrictions is associated with a 20 percent decrease in urban business prices and almost a six percent increase in urban residential prices.