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Three-Part Tariffs and Short-Run Rationality in the Local Fixed Telephone Consumption: Empirical Evidence from Medellín

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  Three-Part Tariffs and Short-Run Rationality in the Local Fixed Telephone Consumption: Empirical Evidence from Medellín
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  65 PRIMER SEMESTRE DE 2010, PP. 147-170.ISSN 0120-3584. DESARROLLO Y SOCIEDAD 147 Three-Part Tariffs and Short-Run Rationality in the Local Fixed Telephone Consumption: Empirical Evidence from Medellín * Tarifa en tres partes y racionalidad de corto  plazo en el consumo de telefonía ja: evidencia empírica para Medellín  Jorge Barrientos ** David Tobón Orozco *** John Fredy Bedoya **** Abstract In this paper we are interested in investigating the effects of the three-  part tariffs system on consumers’ behavior in the local xed telephone service provided by the incumbent Telecommunications Company UNE  in Medellín, which was authorized by the Telecommunications Regulatory Commission ( CRT , for its Spanish name). In order to study consumer behavior and the effect of this tariff system we specify a sort * This paper was presented in the weekly seminar at the Colombian Central Bank (Banco de la República), Medellín 31/07/2009. ** Researcher of the Applied Microeconomics Group at the Centro de Investigaciones y Con-sultorías ( CIC ) and professor of economics, University of Antioquia, e-mail:  [email protected]  Postal Address: Ciudad Universitaria, bloque 13, A. A. 1226, Medellín, Colombia.***   Director of the Applied Microeconomics Group ( CIC )  and associated professor of economics, University of Antioquia, e-mail: [email protected] . Address: Calle 67 núm. 53-108,  bloque 13, ofce 121, Medellín, Colombia. Phone (574) 2195837, fax (574) 2195843. ****   Assistant researcher of the Applied Microeconomics Group ( CIC ) , University of Antioquia, e-mail:  [email protected] . Address: Calle 67 núm. 53-108, bloque 13, ofce 121, Medellín, Colombia. Phone (574) 2195837, fax (574) 2195843. This paper was received January 30, 2009, modied May 7, 2010 and nally accepted May 14, 2010.  148 Three-Part Tariffs and Short-Run Rationality in the Local Fixed Telephone Consumption: Empirical Evidence from Medellín Jorge Barrientos, David Tobón Orozco y John Fredy Bedoya of Engel Curve, which relates expenditure in xed telephone service and expenditure in public utilities. Endogeneity problems could well arise from this specication, so the empirical strategy for studying households’ consumption is based on a panel data analysis by perfor-ming instrumental variables and GMM  procedures. Our results supports the hypothesis that consumers surpass expected consumption levels and therefore the total payment for the service is greater than planned, showing a sort of short-run irrationality in consumption.  Key words : Three-part tariffs, consumers’ behavior, rationality, endo-geneity, GMM  estimators.  JEL  classication : C14, C33, G38, D12, D60. Resumen En este artículo se estudia el efecto de las tarifas en tres partes sobre el comportamiento de los consumidores en el consumo de servicios de telefonía local ja suministrados por la rma UNE , con la autorización de la Comisión de Regulación de Telecomunicaciones ( CRT ). Para ello se especica un tipo de modelo empírico correspondiente a lo que se conoce como curva de Engel, la cual relaciona el gasto en telefonía ja y el gasto total en servicios públicos. Algunos problemas de endogeneidad surgen, de modo que se aplica un método de momentos generalizado a la estructura de datos de panel subyacente. Adicional-mente, se estima un modelo dinámico de datos de panel para observar el ajuste mensual en el consumo. Los resultados sugieren que los consumidores, lejos de aprender de los errores, sistemáticamente se equivocan y sobrepasan su consumo esperado, lo que indica cierta irracionalidad en el corto plazo.  Palabras clave : tarifa en tres partes, comportamiento del consumidor, irracionalidad, endogeneidad, estimadores GMM . Clasicación  JEL : C14, C33, G38, D12, D60.  65 PRIMER SEMESTRE DE 2010, PP. 147-170.ISSN 0120-3584. DESARROLLO Y SOCIEDAD 149 Introduction  Nowadays the use of nonlinear tariffs in public utility services is very common. They are based on the assumption that consumers will  behave rationally by making choices according to their expectation of monthly consumption of telephone minutes. Moreover, that kind of system tariffs are supposed to improve the consumers’ welfare by increasing the surplus of the highest demands, increasing the provider’s revenue and ensuring the participation of the lowest demand in the market (Brown and Sibley, 1983; Willig, 1978). On this regard, Arms- trong (2005) and Reiss and White (2006), among others, nd that it depends heavily on several circumstances; since on the one hand, in a monopoly situation, the provider’s revenue increases greatly, but overall consumer surplus could be reduced, favoring some (mainly high demands) and in detriment of low demands, and on the other hand, under competition, these results will be ambiguous. The nal outcome will depend on the consumers’ response and the information rms have about consumers. A type of non-linear tariff that has been used recently, mainly in tele-communications, is the well-known three-part tariff. It comprises a xed charge, called access price, a “basic” consumption included in the xed charge and a price for each additional unit of consumption in excess of the basic consumption, usually called marginal price. The fixed charge increases with the basic consumption chosen, and the variable charge decreases with each chosen plan. Marginal  price increases if the actual consumption is greater than the “basic” consumption.The effects of this pricing scheme on consumers’ behavior have not  been sufciently explored in the empirical literature. Lambrecht, Seim, Skiera, Thomadsen and Viard (2007) nd that the consumer’s choice is based on the xed charge of the plan rather than on expected consumption, which will be later determined according to the chosen  plan. The consumers’ uncertainty potentially reduces their welfare and increases the rm’s revenues, which are higher than those obtained with a two-part tariff. Nonetheless, the array of consumers’ choices under a scheme designed to maximize prots must be explored from an empirical point of view (see, for instance, Reiss and White, 2006).  150 Three-Part Tariffs and Short-Run Rationality in the Local Fixed Telephone Consumption: Empirical Evidence from Medellín Jorge Barrientos, David Tobón Orozco y John Fredy Bedoya This paper provides empirical evidence on the effects of three-part tariffs on consumers’ behavior in the local xed telephone service  provided by the incumbent Telecommunications Company UNE  in Medellín since February 2006 until December 2006 when TELMEX  entered the market. This non-linear tariff was authorized by the Tele-communications Regulatory Commission ( CRT , for its Spanish name), through Resolution 1250 of 2005, allowing companies to offer to consumers tariff plans according to their consumption needs, which replaced the traditional xed-charge and variable charge per telephone impulse tariff. An important consequence of three-part tariffs we explore is that there are winners as well as losers, which is not only a function of the type of demands, whether high or low, and this kind of tariffs could encourage a persistent increase in consumption over time.The empirical strategy for studying month-to-month households’ consumption is based on a panel data analysis. The rst approach consists of specifying a linear relationship among the regressors (invariant across time), the non-observable heterogeneities and the households’ monthly minutes consumption. The possibility of endoge- neity between minutes consumption (and telephone expenditure) and expenditure on other public utility services (water, garbage disposal and electricity) forces us to correct the problem by performing the Generalized Method of Moments- GMM .The second approach, which is dynamic, consists of specifying a linear relationship between minutes consumption and its lag. Again, in this context endogeneity problems will appear when we try to estimate the  parameter of interest by using a rst-difference model, so that the GMM   estimator offers an alternative to study consumption adjustment over time. The main advantage of the GMM  procedure is that it allows us to use all possible lags as instruments. For the sake of comparison, we also show the estimations using the OLS  approach, Anderson-Hsiao’s  procedure, within-groups estimations, Two-Stage Least Squares (2 SLS ) and GMM .The layout of this paper is as follow: First, non-linear tariff mecha- nisms are dened and three-part tariff consequences on behavior are analytically foreseen. Next, a description of the available information  65 PRIMER SEMESTRE DE 2010, PP. 147-170.ISSN 0120-3584. DESARROLLO Y SOCIEDAD 151 is given and econometric estimation results are offered. Finally, our conclusions and interesting topics for future research are presented I. Nonlinear and three-part tariffs Usually two-part tariffs distinguish between average and marginal  payment 1 . The type of payment is determined by consumers’ socio-demographic and economic characteristics rather than by the company’s cost structure. This payment scheme improves efciency with respect to a tariff system that equals the average cost (provided that the marginal price is less than the average cost); in consequence the resulting decit is compensated with a xed charge (access charge) that turns up from distributing the xed cost among all the demands. The implementation of two-part tariffs will be socially plausible  providing that the xed charge is such that the income-effect is low and ensuring that low-demand consumers are not excluded from the service (low income level or weak preferences).In Colombia, this type of tariff was applied to the local telephone service until 2005, where the average reference cost (CMe R  ) was charged through the monthly tariff T  ( q ) =  F +  p ( q ) where T  ( q ) = (CMe R  – CC)/12 and CC is the connection charge (access to the network). The average reference cost CMe R   is a yearly-based component of the remunerated long term average cost (usually 15 years) with a rate of return of 13% and additional adjustment factors due to total costs dispersion and companies’ demands in the different localities. Moreover, a range for the charge of F was established, that is, 0,15 T  ( q ) « F «0,50 T  ( q ), 1  There are different forms of price discrimination, including charging different consumers different prices for the same good (third-degree price discrimination); making the marginal  price depend on the number of units purchased (nonlinear pricing) or on whether other  products are also purchased from the same rm (bundling); whether this is the rst time a consumer has purchased from the rm (introductory offers; customer “poaching”) or whether the customer has previously purchased other similar goods from the rm. On the other hand, a rm’s range of instruments to discriminate prices depends on the possibility of arbitrage and resale between consumers, on their ability to make anonymous contact with rms and  pretend to be a new customer, thus beneting from introductory prices. Finally it will depend on whether the regulatory entity allows the rm to discriminate prices, keeping maximum  prices or average costs constant and whether it is aware of the possibility of rms passing information to other rms about their customers’ behavior in different markets (Armstrong, 2005).
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