Transcript The Access Pricing Problem - Illinois State University

Introduction
 Simple Framework: The Margin Rule
 Model with Product Differentiation,
Variable Proportions and Bypass
 Model with multiple inputs and outputs
 Conclusion


Efficient Component Pricing Rule (ECPR)
› Formal Definition: that it is efficient to set the
price of access to an essential facility equal
to the direct cost of access plus the
opportunity cost to the integrated access
provider
› Optimal access charge = direct cost of
providing access + opportunity cost of
providing access

The purpose of the paper is to analyze
the meaning of opportunity cost (that is,
the definition of opportunity cost in the BW effect) under supply and demand
conditions to determine access pricing
benchmarks

Set up:
› Single final product
› Two firms:
 Incumbent (the incumbent is assumed to
have control over (monopolize) access)
 Entrant
› Supply: access
 Assumed based on natural monopoly
I – incumbent firm
 C(q,z)

› Cost incurred by I when it supplies q units of z
(access) to E (the entrant)
› C2 is I’s direct marginal cost of providing access
to E
› C1 is I’s marginal cost of providing the final
product to consumers

The Entrant:
› Requires one unit of access from I for each unit
of the final product they supply

Let’s suppose
› E has s units of access
› It incurs an additional cost, c(s) , to supply s units
of final product
› Assumption:
 E has no fixed cost of entry, making c(0) = 0
› Marginal cost denoted c’
› Uniform access pricing is assumed and the
access charge per unit of the input is defined as:
a
› P is the Incumbent’s price for the final product
TC = as + c(s)
 Entrant has a maximum possible profit
given the available margin:

› Available margin: m= p – a
› Profit function
 π(m) ≡ max: ms – c(s)

s(m) < X(P)
› Where X(P) is the consumer demand
function for the final product
› v(P) is consumer surplus
 Where v’(P) ≡ - X(P)

And so, the incumbent’s profit for the
final product P and margin: m = P – a

Π (P, m) ≡ PX(P) – ms(m) – C(X(P)) – s(m),
s(m))

And so, the measure of total welfare
W(P,m) ≡ v(P) + π(m) + Π(P,m)

The welfare maximizing for of pricing for
the incumbent’s products (including
access) subject to a break-even
constraint for the incumbent…….

Note:
› λ≥ 0
as a multiplier for the constraint Π≥ 0

A special case of these Ramsey formulae :
› Break even constrain does not bind, so θ = 0
› Making P = C1
› Meaning:
 If the incumbent’s cost function is such that setting
all prices (including access) = MC does not result in
the firm making a loss
 This is socially optimal
 This is first best access pricing policy

If θ > 0
› Incumbent has increasing returns to technology
› Break even constraint will not bind at social
optimum
› Thus, the Lerner index is positive:
› a > P – [C1 – C2] > C2
› Optimal to set access prices greater than MC of
providing access

Now…since this form of access pricing is
not done by regulators, we have to
consider the practical importance that
› Optimal access pricing: assuming some fixed
and some type of retail tariff imposed by the
incumbent
 This abstracts from the issues of allocative
efficiency

Suppose:
› P, price for the final product, is fixed by
regulation
  X(P), quantity demanded is also fixed
 Fixed retail tariffs
› a = [C2] + [P – C1]
 Which implies that θ = 0
 This optimal charge is consistent with the ECPR


With contestability, the entrant’s
elasticity of supply ηs is zero
In the simple marginal rule,
› P – a should be equal to
› THUS: ECPR = Marginal Rule
[C1 – C2]
Optimal to set the access charge
greater than direct-plus-opportunity-cost
price if the incumbent’s break even
constraint is binding
 The markup over ECPR benchmark is
inversely related to the elasticity of
demand for access
