Competition and Allocative Efficiency: The Case of the U.S. Telephone Industry

This study investigates the effect of competition on the productive efficiency of the U.S. telephone industry, taking into account the fact that the industry was subject to rate-of-return regulation. It is shown that competition induces the incumbents to use capital inputs closer to the unconstrained optima, thereby reducing the allocative inefficiency caused by the Averch-Johnson effect. This effect is in addition to the usual technical efficiency improvement induced by competition. Empirical results, based on annual data for the U.S. telephone industry for the 1951-90 period, suggested that competition improved the allocative efficiency of the incumbent firms which had been under a rate-of-return regulation until 1989. Copyright 1995 by MIT Press.

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