Splitting the Baby: An Empirical Test of Rules of Thumb in Regulatory Price Setting T. Randolph Beard and George S. Ford à I. INTRODUCTION Historically, economists’ interest in regulatory price setting has focused on two largely unrelated problems: first, which prices are efficient given the various complex constraints and circumstances applicable to regulated firms? And second, how are regulated prices actually determined in practice? That these two problems are largely unrelated is commonplace, yet curiously the great bulk of academic research has thus far concentrated on the first. While it is clearly of some utility to understand how efficient prices could, in principle, be determined in some given stylized environment, it is surely more important for policy purposes to understand how prices are arrived at in the ‘real world’. Stigler and Friedland (1962) apparently initiated the analysis of this latter topic, and their answer to the question ‘What can regulators regulate?’ is often somewhat overstated as ‘not much’. Later contributions by Meyer and Leland (1980), Gormley (1983), and many others, have convincingly debunked the notion that regulated prices should be understood as implementations of relatively complex theoretical models of efficient price-setting. The most important, and most politicized, regulatory pricing program of recent times in the United States is that imposed on state public utility commissions by the Telecommunications Act of 1996 (‘The Act’). This Act, which has been the subject of extensive analysis and controversy since its implementation, has as its stated goal the establishment of competitive markets for all telecommunications services, including local services which have historically been the exclusive purview of regulated monopoly providers. Due to the acknowledged presence of large scale economies and sunk costs in local services markets, the Act established a three-pronged avenue for entry KYKLOS, Vol. 58 – 2005 – No. 3, 331–351 r 2005 Blackwell Publishing Ltd., 9600 Garsington Road, Oxford OX4 2DQ, UK 331 and 350 Main Street, Malden, MA 02148, USA à Professor T. Randolph Beard, Department of Economics, 205 Lowder Business Building, Auburn University, Auburn, Alabama 36849, rbeard@business.auburn.edu; George S. Ford, President, Applied Economic Studies, 10221 Vista Pointe Drive, Tampa, FL 33635, gford@aestudies.com and Chief Economist, Phoenix Center for Advanced Legal and Economic Public Policy Studies, 5335 Wisconsin Avenue NW, Suite 440, Washington, D.C. 20015-2034, george.ford@phoenix-center.org.