Question

Before the breakup of AT&T, the firm charged a price for local telephone services that was roughly one-half of its cost of providing the services. In contrast, it charged almost two times it cost for long-distance services.

Why do you think AT&T adopted this pricing strategy? Please give an explanation.

Answer 1

The strategy adopted by telecommunication giant was similar to the one that is adopted by theatre owners where the ticket price is very low but the prices for for food items inside the theatre are very high. This strategy is called cross subsidization in which one group of consumers is charged an artificial in low price while the other group is charged a higher price. In this way one group subsidizes the other

The strategy adopted by AT&T used the fact that the consumers who are willing to make long distance calls definitely need local telephone services. This is because without a telephone service long distance calls cannot be made. Now to include as many consumers as it can the company charged an artificially low price from consumers for local telephone services in order to to encourage them to buy. After they make a purchase, there demand for long distance call become highly inelastic because their willingness to pay is now higher. Therefore this is strategy of cross subsidization is helpful in increasing overall profits.