Level Playing Fields in Regulated Network Industries: Cost-Based Access Pricing, Depreciation, and Capacity Choice

Abstract:     
We investigate cost-based access pricing in regulated network industries. Building on recent progress in the accounting literature, we show that a regulator must choose a particular depreciation schedule, namely, relative replacement cost depreciation in order to prevent the network provider from playing manipulative games with the cost-based access price. We then show that the network provider is put at a strategic disadvantage if the regulator sets the access price equal to long-run incremental costs and the downstream market is symmetric. This result may be understood by looking at strategic interaction in the downstream market where both firms are better off if they behave “softly”. If the regulator sets a low access price, he commits the downstream competitor to price aggressively. Then, the entire burden of softening competition must be borne by the network provider. Finally, since consumer prices are decreasing in the access price, we conclude that the regulator faces a tradeoff between low consumer prices and a level playing field on the downstream market.

Keywords: access pricing, depreciation

JEL Classifications: M40, M46, D40

Working Paper Series