#  Introduction  Simple Framework: The Margin Rule  Model with Product Differentiation, Variable Proportions and Bypass  Model with multiple inputs.

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 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 B- W 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) › C 2 is I’s direct marginal cost of providing access to E › C 1 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 η s is zero  In the simple marginal rule, › P – a should be equal to [C1 – C2] › THUS: ECPR = Marginal Rule

 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

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