Contestable Markets and Telecommunications

Abstract

This chapter¹ provides an economic analysis of the post-divestiture inter-LATA (Local Access and Transport Areas) telephone business. The analysis shows that the industry is not now competitive in its structure, and is unlikely to become more so. Competitive industries used to be defined in terms of the number of competing firms and their relative sizes. However, Baumol and others have introduced and refined the concept of contestability. An industry might have only one participating firm, but if the market were contestable there would be no adverse impact on economic efficiency. In an economically efficient industry, no firm can long sustain prices greater than economic costs. The number and relative sizes of firms does not matter. If the marginal cost structures of actual and potential competitors are similar, and sunk costs are unimportant, then new entry or the expansion of existing firms will destroy the incentives for any firm to set prices above competitive levels.