The Economics of Pricing Network Interconnection: Theory and Application to the Market for Telecommunications in New Zealand

Abstract

Deregulation and the successful introduction of competition to the market for telephone services raise the complex issue of interconnection. Incumbent telephone companies have an incentive to maximize profits by charging entrants the highest interconnection price possible. In New Zealand, the debate over the proper terms of interconnection was brought before the courts under the country's antitrust laws. The incumbent attempted to establish "the parity principle" as the standard for interconnection. As proposed in New Zealand, the parity principle would allow an unregulated monopolist to set access charges at a level sufficient to compensate it for the financial consequences of entry. Justification for this standard lies in claims that any other interconnection rule would be inefficient. Tye and Lapuerta critique these efficiency claims. They argue that the proposed rule would frustrate goals of competition, including: constraining monopoly pricing, enhancing dynamic efficiency and encouraging technological progress. The authors reject the parity principle in favor of a proposal that compensates rival networks for terminating inter-network calls on the basis of long-run incremental cost. They explain how interconnection on these terms can simultaneously promote successful competition and efficiency in the provision of telephone service.