, Volume 5, Issue 1, pp 1-34
Date: 13 Feb 2007

The role of self selection, usage uncertainty and learning in the demand for local telephone service

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Abstract

Telephone services are often characterized by the presence of ‘fixed’ plans, involving only a fixed monthly fee, as well as ‘measured’ plans, with both fixed fees and per-unit charges for usage. Consumers are faced with the decisions of which plan to choose and how much to use the phone and these decisions are not, in general, independent. Due to the presence of a time lag between plan choice and usage decisions, consumers are uncertain about usage at the plan-choice stage. We develop a structural discrete/continuous model of plan choice and usage decisions of consumers that accounts for such uncertainty. Prior research has also found that consumers switch less often from fixed plans to measured plans to gain from potential savings than vice versa. Consumer uncertainty regarding their mean usage levels and different rates of learning by consumers in the two plans is a potential explanation for this phenomenon. We extend our discrete/continuous model to account for consumer learning about their mean usage and estimate different rates of learning for the two types of plans.

We estimate our model using data from the 1986 Kentucky local telephone tariff experiment. Even in the absence of any price variation over time, we are able to measure the price elasticities both of usage and of choice of plan. Using our parameter estimates, we simulate the effects of the introduction of a metered plan in a market with only a fixed plan and vice versa, on both firm revenues and consumer surplus. We also find that consumers learn very rapidly if they are on the measured plan but learn very slowly when they are on the fixed plan. We investigate an alternative assumption on the nature of the learning process in which only consumers in the measured plan have an opportunity to learn. We find that our empirical results are robust to this change of specification. We conduct counterfactual simulations to simulate enhanced calling plans from the firm and consumer points of view. Additional simulations to measure the value of information in this category are also carried out. We compute the value of both complete information, where the entire uncertainty about future usage is resolved, as well as that of limited information, where the consumer's uncertainty about mean usage is resolved, but the uncertainty about specific month-to-month usage remains. We find that the value of information is modest. We also find that a large proportion of the value of information is that about the mean usage, with the value of the information about a specific month's usage being relatively small.

JEL Classification D12 · D83 · K23 · L11 · L96 · M31