J Regul Econ (2006) 30:217–231 DOI 10.1007/s11149-006-0012-7 ORIGINAL ARTICLE Incentive regulation in local telecommunications: The effects on price markups Sarah B. Eckenrod © Springer Science+Business Media, LLC 2006 Abstract The governing bodies of the telecommunications industry instituted a ma- jor shift from rate of return to price cap regulation in an effort to foster competition and improve efficiency. This paper focuses on the local exchange market and exam- ines the price markup before and after the implementation of price cap regulation to measure the effects of the change on consumer welfare. The average price markup increased slightly after price cap regulation; however, the average price decreased, indicating that consumers benefited without firms losing from the regulatory shift. Keywords Telecommunications · Regulation · Price cap · Translog JEL Classification Economics of regulation (L51) · Industry studies-utilities and transportation-telecommunications (L96) 1 Introduction In recent years, the local exchange telecommunications industry’s regulations have been overhauled to promote competition and efficient production. With the Tele- communications Act of 1996 (The Act), the Federal Communications Commission (FCC) shifted the regulatory motivation to regulation to promote competition in the local exchange market. Between 1991 and 2002, most state public utility commissions made an analogous shift in their governance of local and intralata toll calls increas- ingly shifting from rate of return with earnings or revenue sharing to price cap and rate freeze regulation. 1 1 See Ai and Sappington (2002) for details on changes in regulation types by year. S. B. Eckenrod (B ) University of Massachusetts Dartmouth, 285 Old Westport Road, North Dartmouth, MA 02747, USA e-mail: seckenrod@umassd.edu