Social welfare loss due to second-best pricing: an application to the portuguese telecommunications

Abstract

The Telecommunications industry is usually characterised by low marginal costs and significant fixed costs which are the conditions for the inefficiency of marginal cost pricing. In such cases theory postulates that optimal pricing is obtained by maximising welfare subject to a restriction of viability of the firm: the second-best pricing scheme. The possible Welfare Losses due to second-best pricing varies according to the values of marginal costs, prices and demand elasticities. In this paper we intend to analyse to what extent the second-best pricing has been achieved in the Portuguese Telecommunications firm CTT, over the period 1950-1984 as well as the magnitude of the price-cost margins and Welfare Losses created. We obtained empirical evidence of the presence of economies of scale, a Welfare Loss estimate of 1% of the Telecommunications receipts and a result that price was 40% greater than marginal cost. We concluded that price regulation and public ownership of the firm did not seriously affect social welfare over the sample period (it should be noted that it is the non-digital and fixed-wire infrastructure period). Therefore, it is important to study the impact of new digital and non-wire technologies and new services provided in the old regulatory scenery.