Why Ramsey Pricing Is Wrong: The Case of Telecommunications Regulation
In a recent telecommunications case before the Oregon Public Utility Commission, two of the PUC's staff economists suggested that improvements in social welfare would accrue if common costs were allocated on the basis of what some economists call the Inverse Elasticity Rule and others, Ramsey Pricing. The essence of this allocation principle is to allocate common costs to customer classes in proportion to the elasticity of demand of the various classes of service: those classes with inelastic demands would bear the largest share of costs, while those classes with more elastic demands would be assigned a smaller share. On cross examination these economists testified that the adoption of Ramsey Pricing would require increases in the price of basic residential service of approximately 120 percent,' resulting in loss of service to 6 percent of current subscribers2 (approximately 40,000 residential customers).3 When asked to explain how this loss of basic service to so many residential customers could be justified on social welfare grounds, they responded that lower prices for other services (such as call forwarding) resulting in expanded usage more than made up for the losses.4 When asked how many new sign-ups for call forwarding would justify the loss of basic service to one household, the response was, "11 1."I Finally, when asked whether their analysis took into consider-