Nonparametric Analysis of Cost Complementarities in the Telecommunications Industry

The market structure of the telephone industry has been the focus of much empirical research following the divestiture of AT&T in 1984. Using data on Local Exchange Carriers (LECs), I estimate the total cost function of LECs operating between 1988 and 1995. First, I show that cost complementarities can be nonparametrically identified in many situations where economies of scope and subadditivity - the focus of previous empirical research - cannot be identified. Next, I implement a feasible estimation model that is consistent with the properties that a cost function needs to satisfy according to economic theory. The telephone companies are treated as multi-product firms producing two outputs: local and toll calls. The results support the assumption of cost complementarities in the production of both outputs. The degree of complementarity is computed and shown to be larger for small companies.