Exhibit 1.6. The first order economic benefits will correspond exactly to the user benefit as measured in Exhibit 1.5; there will be a further second order (welfare triangle) benefit which is not captured in the calculation as illustrated in Exhibit 1.5 (although it does also constitute a user benefit).
The situation is less straightforward when there is a cross subsidy within the industry. These cases are illustrated in the lower diagrams on Exhibit 1.6. In the case of a service which is providing a substantial subsidy, such as the international service from Hong Kong, the cost represents only a proportion of the price. The 15% drop in price can be expected to produce a corresponding 15% improvement in cost efficiency, but the magnitude of this improvement in absolute terms is much smaller due to the large gap between price and cost (see Exhibit 1.6, case 2). The result is a discrepancy, for that element of service usage which already existed prior to the price cut, between user benefits and true economic benefits. However there is a further economic benefit resulting from the stimulation of demand due to the price change. Unlike in case 1, this is now a first order rather than second order benefit (i.e. a rectangle as well as a triangle on the illustration) because of the substantial margin of price over cost. It is not possible to say a priori whether the shaded area corresponding to true economic benefit in case 2 (Exhibit 1.6) is larger or smaller than the shaded area corresponding to user benefit as measured in Exhibit 1.5; this will depend on the elasticity (slope) of the demand curve.
Case 3 on Exhibit 1.6 illustrates the converse case, that of a subsidised service (such as the residential telephone service). The improvement in cost performance in respect of those customers buying service at the old price is in this case greater than the fall in price, due to the high margin between cost and price. However there is an offsetting disbenefit, shaded appropriately on Exhibit 1.6 (case 3), representing the adverse welfare impact of the external demand stimulated by the price change. As in case 2, it is not possible to state a priori, i.e. without knowledge of the slope of the demand curve, whether the true economic benefit will be greater or less than the user benefit as measured in Exhibit 1.5.
Taking all these factors into consideration, and recognizing the complexity introduced by changes in cross subsidy structure which may follow the introduction of competition, we believe that the user benefits represent a useful first order approximation to the true economic benefits. In much of the analysis in this report we will treat the two, therefore, as identical.
An analysis of benefits and costs should consider not only aggregate gains or losses, but also the distribution of benefits among members of the population. Particularly when there is a structure of cross subsidy in place, the incidence of benefit redistribution can be quite complex. By and large, the introduction of a more competitive industry structure tends to reduce the extent of cross subsidy among different users of a service. This does not always follow, but it is the long run response most commonly observed, not only in the telecommunications industry but also in markets such as airline transportation. Therefore benefits will tend to fall more heavily on those users which were formerly cross
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