Optimal Resale Charge and Network Quality

Abstract

Based upon facility-based competition, the extent and quality of telecommunications service in Korea have reached one of the best in the world. However, since new entrants have not come into the market for the last decade or so, the Korea Communications Commission is considering service-based competition so as to enhance competition further and to lower prices. Introduction of service-based competition requires resale. This paper studies the resale charge, service price and network quality inducing welfare-maximizing social optimum. We modified the Hotelling's linear city model into a two-stage model to make possible vertical as well as horizontal product differentiation. The study finds the followings. First, socially optimal level of network quality is identified for the purpose of comparison. Second, under the cost-plus relgulation, the profit-maximizing quality is found to be different from the social optimum. Third, the optimal resale charge should be based on the retail-minus principle rather than the cost-plus principle in order to insure the socially optimal level of network quality. Fourth, the retail-minus regulation does not produce socially optimal prices. Fifth, with the assumption of full market coverage, the equilibrium prices resulting from the retail-minus regulation are higher than the comparable monopoly price. The last result shows that application of the retail-minus regulation alone cannot guarantee the social optimum.