TELECOMMUNICATIONS DEMAND IN THEORY AND PRACTICE

TELECOMMUNICATIONS DEMAND IN THEORY AND PRACTICE by LESTERD. TAYLOR Department of Economics, University ofArizona, Tucson, Ariz., U.S.A .

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SPRINGER-SCIENCE+BUSINESS MEDIA, B.V.

Library of Congress Cataloging-in-Publication Data Taylor, Lester D. Telecommunications demand in theory and practice / by Lester D. Taylor. -- [Rev. ed.l p. cm. Rev. ed. of: Telecommunications demand. c1980. "March 1993." Inc 1udes bib 1 i ograph i ca 1 references and index. ISBN 978-0-7923-2675-5

ISBN 978-94-011-0892-8 (eBook)

DOI 10.1007/978-94-011-0892-8

1. Telephone--United States. 2. Telephone--Mathematical models. I. Taylor, Lester D. Telecommunications demand. II. Title. HE8815.T395 1994 384.S'0973--dc20 93-14522

ISBN 978-0-7923-2675-5

Printed on acidjree paper

All Rights Reserved © 1994 Springer Science+Business Media Dordrecht Originally published by Kluwer Academic Publishers in 1994 Softcover reprint of the hardcover 1st edition 1994

No part of the material protected by this copyright notice may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without written permission from the copyright owner.

To EDL and PBL, whose efforts and support made the 1980 book possible

TABLE OF CONTENTS

LIST OF FIGURES

xi

LIST OF TABLES

xiii

PREFACE

xvii

CHAPTER 1 / INTRODUCTION AND OVERVIEW I. II. III. IV.

Background Recent Methodological Developments Conferences and Special Volumes Plan of Book

CHAPTER 2 / THE THEORY OF TELEPHONE DEMAND I: BASIC RESULTS I. II. III. IV.

Some Basic Considerations Recent Contributions to the Theory of Telephone Demand Consumption Externalities and Communities of Interest A Framework for Analyzing Telephone Demand V. Relationships Between Price and Income Elasticities for Access and Usage VI. Option Demand

1 1 3 6 7

8

8 10 23 24 31 33

CHAPTER 3 / THE THEORY OF TELEPHONE DEMAND II: EXTENSIONS OF BASIC RESULTS

36

I. The Duration and Distance Dimensions of Telephone Demand II. Time-of-Day Pricing III. Operator-Handled Versus Direct-Dialed Calls IV. Some Further Dynamics V. The Usage of Price Deflated Revenues VI. Firm vs Market Elasticities VII. Logistic Approaches to Forecasting VIII. Concluding Comments

36 48 50 51 54 56 61 63

CHAPTER 4 / BUSINESS TELECOMMUNICATIONS DEMAND

65

vii

viii

Table of Contents

I. II. III. IV.

Some Basic Considerations A General Model of Business Demand Some Specific Models of Business Demand Business Demand From the Point of View of the Local Exchange Company V. Wrap-up and Summary

CHAPTER 5 / RECENT STUDIES OF RESIDENTIAL ACCESS DEMAND I. The 1983 Perl Study II. Southwestern Bell's Residential Access Demand Model: Taylor and Kridel (1990) III. Bell Canada's Residential Access Demand Model IV. Train, McFadden, and Ben-Akiva (1987) V. Evaluation CHAPTER 6 / RECENT STUDIES OF TOLL DEMAND I. II. III. IV. V.

Toll Demand in Ontario and Quebec Point-to-Point Toll Demand The Demand for Interstate Access Minutes The Demand for Bypass of the LEC Wrap-up

CHAPTER 7 / THE DEMAND FOR LOCAL CALLS AND RELATED LOCAL SERVICES I. Local Calling and the Choice Between Flat-Rate and Measured Service II. Bypass Via EAS: Kridel (1988) III. Results From the GTE Measured-Service Experiment: Park, Wetzel, & Mitchell (1983) IV. The Demand for Custom-Calling Features

65 68 73 80 83 85 86 96 107 111 125 129 130 132 141 145 147

149 149 163 169 174

CHAPTER 8 / BUSINESS TELEPHONE SYSTEM DEMAND, I. II. III. IV.

Total-Bill and Socio-Demographic Effects Business Telephone System Demand Total-Bill Effects Socio-Demographic and Other Characteristics of Telecommunications Demand

193 193 200 204

Table of Contents CHAPTER 9 / CONSUMPTION EXTERNALITIES I. The Network Externality and the Optimal Pricing of Telecommunications Services II. An Alternative Measure of the Network Externality III. Distributional Equity IV. Some Remaining Questions V. Call Externalities VI. Empirical Evidence Regarding Consumption Externalities VII. Conclusions CHAPTER 10 / PRICE ELASTICITIES IN THE HEARING ROOM: THE PROMISE AND LIMITS OF ECONOMETRIC ANALYSES OF TELECOMMUNICATIONS DEMAND I. The Structure of an Econometric Study II. Econometrics in the Hearing Room: Some Guiding Precepts III. Some Pitfalls in Using Econometric Models CHAPTER II/EvALUATION AND CONCLUSIONS I. What We Appear to Know About the Structure of Telecommunications Demand II. Problem Areas III. Demand Analysis in a CompetitiveiPartially Regulated Environment APPENDIX 1 / THE PRE-1980 EMPIRICAL LITERATURE ON TELEPHONE DEMAND: ACCESS, LOCAL SERVICE, AND INTERSTATE TOLL I. The Demand for Access II. The Demand for Local Use III. Long-Haul (Interstate) Toll Demand APPENDIX 2 / THE PRE-1980 EMPIRICAL LITERATURE ON TELEPHONE DEMAND: INTRASTATE TOLL, WATS AND PRIVATE LINE, COIN, ETC. I. Intrastate Toll Demand II. WATS and Private Line III. Coin Stations

ix

212 213 218 222 230 231 236 238

241 242 251 252 255 256 266 270

271 271 283 295

315 315 328 332

x

Table of Contents

IV. Vertical Services V. The Impact of Service-Connection and Other Nonrecurring Charges VI. International Demand VII. Yellow-Pages Advertising VIII. Noneconometric Approaches to Forecasting Telephone Demand

336 338 341 345

APPENDIX 3 / NETWORK EXTERNALITY AND THE DEMAND FOR RESIDENTIAL LONG-DISTANCE TELEPHONE SERVICE: A COMMENT

349

I. A Model of Toll Demand II. Isolation of the Network Externality III. Conclusions

334

349 355 368

BIBLIOGRAPHY

370

INDEX

398

LIST OF FIGURES

Figure 2-1

Relationship between the Conceptual Demand Curve and Observed Market Demand Curve for Calls

Figure 2-2

Certainty-Equivalent of an Incoming Call for a Risk-Averse Subscriber

Figure 3-1

Budget Constraint with Decreasing Block Pricing

Figure 3-2

Consumer Equilibria with Decreasing Block Pricing

Figure 3-3

Effect of a Change in Intramarginal Price

Figure 3-4

Effect of a Change in Both Intramarginal and Marginal Price

Figure 3-5

Price Change That Leads to Switching of Blocks

Figure 3-6

Effect of an Income Change

Figure 3-7

Multiple Equilibria

Figure 3-8

Change in Fixed Charge

Figure 3-9

Change in Marginal Price

Figure 3-10 Benefits of Migration for Different Values of (3 Figure 3-11 Benefits from Migration for Different Levels of Income Figure 5-1

Access Price and Demand for Telephone Service; 1983 and 1978 Models; Perl Study

Figure 7-1 Figure 7-2 Figure 7-3 Figure 7-4 Figure 7-5 Figure 7-6 Figure 7-7

Service 1 and Service 2 with Discount

Figure 7-8

Actual vs. Predicted Penetration

Figure 7-9

Penetration by Income Quartile; Actual vs. Predicted xi

xii

List of Figures

Figure 8-1

Telephone Spending by Income Group for United States

Figure 8-2

Spending on Telephone Service as % if Average Current Consumption for Canada

Figure 9-1 Figure 10-1 Structure of an Econometric Study

LIST OF TABLES

Table 4-1

Business Telecommtmications Needs

Table 4-2

Suggested Models for Business Usage, Access, and Customer Premise Equipment

Table 5-1

1983 NERA Telephone Access Demand Equation: Parameters and Mean Values of Variables

Table 5-2

1978 NERA Telephone Access Demand Equation: Parameters and Mean Values of Variables

Table 5-3

Price Elasticity at Alternative Prices and Telephone Penetration Rates; Perl Study

Table 5-4

Telephone Penetration Rates at Alternative Flat and Measured Rate Prices; Perl Study

Table 5-5

Telephone Penetration by Income Group; 1983 and 1978 Models; Perl Study

Table 5-6

Coefficient Estimates; Taylor-Kridel Study

Table 5-7

Development and Repression for 100% Access Price Increases; Taylor-Kridel Study

Table 5-8

Development and Repression for 100% Access Price Increases for Texas; Taylor-Kridel Study

Table 5-9

Impact of "Current" FCC Access Charge Plan; Southwestern Bell; Taylor-Kridel Study

Table 5-10

Estimation Results; Bell Canada Study

Table 5-11

Description of Explanatory Variables; Bell Canada Study

Table 5-12

Penetration Elasticities by Province; Bell Canada Study

Table 5-13

Penetration Price Elasticities by Size of Area of Residence, Age, & Income; Bell Canada Study

Table 5-14

Service Options in TMB Study

Table 5-15

Time & Zone Categories in TMB Study

Table 5-16

Logit Model of Service Choice for Given Portfolio; TMB Study xiii

xiv

List of Tables

Table 5-17

Logit Model of Service Choice Conditional on Portfolio; TMB Study

Table 5-18

Estimated Price Elasticities; TMB Study

Table 6-1

Bell Canada Bell-Intra Models; Double Logarithmic

Table 6-2

Point-to-Point Model of Larson, Lehman, and Weisman

Table 6-3

Flow-Through Price & Income Elasticities; Larson-LehmanWeisman Study

Table 6-4

Telecom Canada Models; Price and Income Elasticities; Canada-Canada

Table 6-5

Telecom Canada Models; Canada-U.S.

Table 6-6

AT&T State Pooled PDL Model for Interstate Access Minutes

Table 6-7

Price Elasticities for Switched and Dedicated Access; Watters & Grandstaff Study

Table 7-1

Kling-Van der Ploeg Model; Coefficient Estimates

Table 7-2

Price Elasticities of Demand; Kling-Van der Ploeg Study

Table 7-3

Coefficient Estimates; Kridel Study

Table 7-4

Comparative Statics; Kridel Study

Table 7-5

Predictions from Kridel Model

Table 7-6

Tariffs in Effect During the GTE Local Measured-Service Experiment

Table 7-7

Estimated Price Effects in Park, Wetzel, & Mitchell Model

Table 7-8

Estimated Price Elasticities at December 1979 Experimental Prices; Park, Wetzel, & Mitchell Study

Table 7-9

Coefficient Estimates; Kridel-Taylor Study

Table 8-1

Demand Effects; Ben-AkivaiGershenfeld Study

Table 8-2

Own-Price Elasticities; Ben-AkivaiGershenfeld Study

Table 8-3

Estimates of Price Elasticities; Zona-Jacob Study

Table 9-1

Value of Telephone Service to the Average House hold at Various Local Network Sizes; Perl Study

Table 11-1

Abridged Guide to Post-1980 Research on Telecommunications Demand

Table A1-1 Estimates of Price and Income Elasticities of the Demand for Access to the Telephone System

List o/Tables

xv

Table AI-2 Estimated Price Elasticity of Demand with Respect to the Income-Adjusted Basic Monthly Service Charge; Logit Model, 1978 Perl Study Table AI-3 Estimates of the Parameters in Equation (30) Table AI-4 Estimates of Price and Income Elasticities of the Demand for Local Use and Local Service Table AI-5 Estimates of Price and Income Elasticities of Demand for LongHaul Toll Calls for the United States and Other Countries Table AI-6 Two Equations for Deschamps' Study of Demand for Calls in Belgium Table A2-1 Estimates of Price and Income Elasticities of Demand for Intrastate Toll Calls; Bell System Table A2-2 Coefficients of Market-Size Variable; Bell System Intrastate Toll Demand Models Table A2-3 Estimates of Price and Income Elasticities for Intrastate Toll Demand; Feldman Study Table A2-4 Estimates of Day/Night Price and Income Elasticities; Stuntebeck Study, Cross-Section Sample Table A2-5 Estimates of Day/Night Price and Income Elasticities; Stuntebeck Study, Pooled Sample Table A2-6 Estimates of Price and Income Elasticities of Demand for WATS; Feldman Study Table A2-7 Estimates of Price and Income Elasticities of Demand for WATS and Private Line; Davis et al. Study Table A2-8 Estimates of Price and Income Elasticities of Demand for PayStation Toll Calls; Feldman Study Table A2-9 Estimates of Price and Income Elasticities of Demand for Vertical Service Table A2-10 Estimates of Price and Income Elasticities for International Telephone Demand; Part I Table A2-11 Estimates of Price and Income Elasticities for International Telephone Demand; Part II Table A3-1 Comparison of Price and Market Size Elasticities from CNCP and Bell Canada Toll Demand Models Table A3-2 Unconstrained Estimation; Breslaw Model

xvi

List of Tables

Table A3-3 Bell Canada DDD Off-Peak Long Haul Model; Alternative Measures of Market Size; 509 Data Table A3-4 Variance Decomposition Matrix for Breslaw Model in Table A3-2 Table A3-5 Variance Decomposition Matrix for Equation (l) in Table A3-3 Table A3-6 Local Conversations; Breslaw Model Table A3-7 Mixed Estimation; Breslaw Model

PREFACE

Readers familiar with my 1980 book, Telecommunications Demand: A Survey And Critique, will find this edition almost entirely new. The only chapters from the 1980 book that are retained are the chapter on the theory of telephone demand (which is extended and now appears as two chapters) and the two chapters summarizing the empirical literature as it existed in the late 1970s. Those two chapters are now reproduced, with minor editing, in Appendices 1 and 2. The 1980 book consisted of five chapters and a Postscript; this edition consists of 11 chapters and three appendices, plus a greatly expanded bibliography. The 1980 book attempted to provide an exhaustive review of the empirical literature; this book is necessarily selective in its empirical review, as the post-1980 literature is simply too massive for an exhaustive review to be feasible. Work on this edition was started in 1986, and has obviously taken much longer than I had planned. Much of the empirical work that is discussed reflects studies and research that I was involved with throughout the 1980s on a consulting basis at Southwestern Bell and Bell Canada and in very recent years in conjunction with the National Telecommunications Demand Study. Unlike the 1980 book, however, which was underwritten by AT&T, this edition has benefited from no corporate funding. Although the changes that have transformed the structure of telecommunications in the U.S. are echoed in many other countries, the focus in this edition continues to be on North America. I regret not including studies on telecommunications demand from Europe and other parts of the world in the discussion, but to do so has simply not been feasible. I have, however, included several recent European and Australian studies in the bibliography. As with the 1980 book, many people have given generously of their time and energy in chasing down studies and references, making unpublished studies available, offering advise, comments, and counsel, and providing ego-boosting encouragment that a new book was indeed worthwhile. The list includes to begin with: D. Kridel, A. Larson, J. Chen, J. Watters and D. Weisman of Southwestern Bell and T. Appelbe, J. Bodnar, P. Dillworth, S. Iacono, M. Manton, F.D. Orr, D.L. Solvason and S. Subisatti of Bell xvii

xviii Preface Canada. Also: J. Alleman of the University of Colorado, A. Belinfante of the FCC, W. Boal of Pacific Telephone, 1. Colias of Bell South, R. Dansby of BELLCORE, M. Ben-Akiva of M.LT., G. Duncan of GTE Laboratories, B. Egan of Columbia University, D. Elixmann of the Wissenschaftliches Institut fUr Kommunikationsdienste GmbH, J. Gatto and P. Robinson of AT&T, J. Griffin of Texas A. & M. University, 1. Hausman ofM.I.T., R. Jacob of United Telecom, J. Kling of Michigan Bell, J. Langin-Hooper of Langin-Hooper Associates, S. Levin of the University of Southern lllinois at Edwardsville, A. Margeson of Andy Margeson Associates, J. Mayo of the University of Tennessee, P. Pacey of Pacey-Johnson Associates, T. Perez-Amaral of the University of Madrid, D. Perry and Dennis Trimble of GTE, L. Perl, T. Tardiff, W. Taylor and D. Zona of National Economic Research Associates, W. Pollard of the National Regulatory Research Institute, F. Sabetan of Pacific Bell, K. Train of the University of California at Berkeley, G. Wall of the Canadian Cable Television Association, and P. Zweifel of the University of Zurich. I am particularly indebted to Judi Bodnar, Bruce Egan, Dieter Elixmann, Sandy Levin, Teodosio Perez, Tim Tardiff, and Peter Zweifel for careful reading and critique of the manuscript and to my colleague Leslie Stratton for her assistance in deriving some of the formulae in Section N of Chapter 7. Special thanks are also due to Rick Emmerson, Don Michels and Paul Rappoport, my colleagues in the National Telecommunications Demand Study, for their contributions and support, as well as to my longtime collaborator, Don Kridel. I am especially indebted to R. Bruce Williamson of Southwestern Bell for making available his extensive bibliography on the regulated industries, much of which is reproduced in the bibliography at the end of the book. Finally, I am grateful to Patricia Lenoir and Mary Flannery for expert word processing and preparation of the manuscript and to Alison Habel for preparation of the graphs and charts. Lester D. Taylor March 1993

Heck of a Hill Wilson, WY.