The name is absent

proach and is the one which the EC proposes to be extended for mobile communication
markets in a recommendation of 07 May 2009.⁷ The alternative regulation scheme is
incentive regulation meaning either price- or revenue-cap regulation. Table 1 provides
an overview of the alternative regulation approaches which are in place in Europe.
Cost-based regulation forces termination rates to be chosen at cost-level or a constant
mark-up above costs. With cost-based termination rates investments in cost-reduction
are directly passed on to the investor’s termination rates. While the investment exter-
nalities on incoming calls are higher with cost-based regulation than without regulation
the wholesale price-cost margin remains constant. Concerning the effect on profits from
outgoing calls to the investor a stronger reduction in retail prices is observed since the
mitigating effect of cost-reduction on optimally chosen termination rates is abolished.
The price effect is overcompensated in the competitors’ profit functions by a higher
demand for outgoing calls. Note that LRIC regulation as it is usually defined in the
literature is a simplification of the more technical definition as it is given in Laffont and
Tirole (2001):

"LRIC=Marginal cost of date-t production of the most efficient technology × (Interest
rate + Rate of technological progress + Rate of physical depreciation of the equipment)"⁸
If LRIC regulation were introduced in the strict sense competitors were forced to reduce
their termination rates in line with an investment. In consequence, this would deter
the outcome twice: First, the investor’s retail price would decrease more than without
regulation and even more than with standard cost-based or incentive regulation as the
competitors’ termination rate reduction stronger affects the investor’s price-cost margin.
Second, the competitors’ wholesale price-cost margin would also be deterred increasing
the off-net traffic between competitors. Thus, under LRIC regulation the strategic-
instrument-character of investments is enhanced in the short-run (increasing incoming
traffic and reducing competitors’ profit margins). In contrast, with standard cost-based
regulation direct investment effects vanish as termination rates are unaffected by com-
petitors’ investments but are in place with the LRIC form.

With price-cap regulation an upper bound for termination rates is set by the regulator
based on a price basket of telecommunication services. Thus, by investing in cost-
reduction MNPs directly gain from a higher wholesale price-cost margin. Nevertheless,

⁷ http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/710&format=HTML&aged=
0&language=EN&guiLanguage=en

⁸see Laffont and Tirole (2001), p. 151

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