CROSS-SUBSIDIZATION AND COST MISALLOCATION BY REGULATED MONOPOLISTS

While cross-subsidization is understood theoretically as involving the sustainability of a cost allocation scheme, it is invoked in regulatory policy contexts, such as the divestiture of AT&T, where costs of serving unregulated markets may be borne by ratepayers of regulated monopolies. We analyze two cross-subsidization tactics-cost misallocation and distorted technological choice - under a spectrum of regulatory cost allocation policies. These tactics lead to higher prices in regulated markets and inefficient production in unregulated markets. Welfare effects are discussed; we conclude with observations on strategic behavior and regulatory policy. © 1990 Kluwer Academic Publishers.