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Modelling cost structure: the Bell System revisited

Author: Röller, Lars-Hendrik INSEAD Area: Economics and Political ScienceIn: Applied Economics, vol. 22, no. 12, December 1990 Language: EnglishDescription: p. 1661-1674.Type of document: INSEAD ArticleNote: Please ask the Library for this articleAbstract: This paper argues that models of multi-output cost structure using the translog specification are subject to two major criticisms. First, considerable robustness problems of crucial functional properties (like economies of scope and subadditivity) could be present when translog functional forms are used. It is suggested that this non-robustness is due to what is termed "Flip-Flop" property of the translog model, and it is shown that the available empirical evidence for the pre-divestiture Bell System supports this argument. Second, multi-output translog cost functions may not constitute proper cost function for much of the output space. It is suggested that the analysis should be constrained to the part of output space that is proper. Using the test for natural monopoly proposed by Evans and Heckman (1984) and imposing properness on the test region, it is found that the available data for the pre-divestiture Bell System are consistent with a natural monopoly. Furthermore, this result is robust
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This paper argues that models of multi-output cost structure using the translog specification are subject to two major criticisms. First, considerable robustness problems of crucial functional properties (like economies of scope and subadditivity) could be present when translog functional forms are used. It is suggested that this non-robustness is due to what is termed "Flip-Flop" property of the translog model, and it is shown that the available empirical evidence for the pre-divestiture Bell System supports this argument. Second, multi-output translog cost functions may not constitute proper cost function for much of the output space. It is suggested that the analysis should be constrained to the part of output space that is proper. Using the test for natural monopoly proposed by Evans and Heckman (1984) and imposing properness on the test region, it is found that the available data for the pre-divestiture Bell System are consistent with a natural monopoly. Furthermore, this result is robust

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