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Fortnightly Magazine - July 15 1997

calculating profit margins directly, the authors (Kahai, Kaserman and Mayo) estimate a "dominant firm/competitive fringe" econometric model of the long-distance industry. They find that AT&T faces a demand price elasticity ranging between -3.73 and -7.81 in the least-competitive, long-distance market segment. They speculate demand is even more price elastic in the most competitive business service segments. These elasticity values correspond, respectively, to Lerner Index values of 0.27 and 0.13, %n5%n and so, by the "inverse elasticity" rule, to profit margins of 27 percent and 13 percent.

After comparing their findings with data for other industries, KK&M find that the long-distance industry might be the most competitive of all, a result that flatly contradicts MacAvoy's findings. The authors, therefore, conclude that AT&T lacks significant market power.

Why is the research split over this issue?

A Theory of Behavior

Empirical studies necessarily rely upon historical price and quantity data. They assume that the data reflects classical profit-maximizing conduct, as predicted by economic theory. Therein lies the potential for misinterpretation.

The studies described above both recognize that the long-distance industry does not operate unfettered, but rather under regulatory and antitrust rules. However, neither study seeks to control for the effect of these rules.

Moreover, neither study seeks to explain one fascinating aspect of long-distance market structure: Why did market shares stabilize where they did? In particular, why did AT&T's market share stabilize at roughly 60 percent across all service segments? Historical market shares may represent nothing more than an admixture of chance, cost and the subjective valuations of long-distance users. Or, they may help to explain the conflict among empirical studies. Here's why.

For roughly a decade beginning in 1976, AT&T assumed MCI's mantle of a law firm with antennas. During this period, AT&T diverted its financial, technical and managerial resources to a defense against antitrust actions. Some of these were little more than nuisance suits. Those brought by MCI, Sprint, and the U.S. Department of Justice were substantial by any standard.

At the time of divestiture, AT&T was the dominant supplier of long-distance services, with market shares approaching 90 percent. Many industry pundits predicted that unfettered competition, coupled with uniform access charges, would quickly force AT&T's competitors out of business and push AT&T's market shares back toward 100 percent. How better for AT&T to protect itself against the cost of post-divestiture litigation and asymmetric regulation than to reduce its market shares below monopoly levels?

Economic theory does not pinpoint the level of market share needed to attain "monopoly" status. However, a practical answer can be found in federal court dicta. In United States v. Aluminum Company of America, %n6%n the court offered an offhand definition of monopoly while wrestling with the related issue of how to fix the size of the relevant product market. By one measure, the defendant held a 90-percent market share; by another it held only 64 percent. The court speculated that a 90-percent share "is enough to constitute a monopoly [though] it is doubtful whether sixty or sixty-four percent would be enough." This dicta remains the informal test for monopoly