Multiple outputs, adjustment costs and the structure of production for Bell Canada

A dynamic model of production is developed and estimated for Bell Canada. Dynamic models are forward-looking so that forecasts are required of the exogenous variables. Equations are specified which define these expectations-generating processes. In this model, output is disaggregated into local and toll categories. The dynamics arise from adjustment costs associated with changes to the capital stock. It is estimated that for $1.00 of marginal capital costs there are additional adjustment costs of $0.40. Price, output and scale elasticities are estimated. The existence of adjustment costs shows that the effects of price and output changes on factor demands are each significantly different from the effects obtained from static models without adjustment costs. Thus substantial forecast errors with respect to input requirements will be made if adjustment costs are ignored. The disaggregation of output into local and toll categories allows for the differential effects on production cost. The relatively small effect that toll output exerts on variable cost is the reason that Bell Canada exhibits increasing returns to scale.