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Fortnightly Magazine - July 15 1997

in the federal case law.

It may be only a coincidence that AT&T's market share has leveled off at 60 percent. Scholars, however, have focused on the fact that AT&T hemorrhaged market share until reaching 60 percent, at which point it acted to staunch its losses. Former Justice Department Consultant Peter Huber observed, for example:

In 1990, AT&T openly declared its intention to stabilize its share position ... AT&T can, and does, unilaterally decide what share it will hold or cede in the long distance market. %n7%n

If AT&T manipulated its market share to avoid being heckled by bureaucrats and competitors, then its "exercise" of market power over price may be merely an artifact of its preference for a safe harbor from renewed antitrust and regulatory action.

The economics of this market strategy are depicted in Figure 1. If AT&T were to exercise market power to maximize profits, then (by standard economic reasoning) it would choose price and quantity as determined by the intersection of its marginal cost and marginal revenue curves. By so doing, AT&T would fully exploit both its cost advantages and the subjective valuations of long-distance users.

By adopting a pure profit-maximizing strategy, AT&T would generate a market share that exceeded the presumed antitrust threshold. Instead, AT&T could choose to restrict output to Q*, a point at which its market share was equal to or comfortably near that threshold. How might that occur? Under one strategy, AT&T could reduce quantity by shifting demand (D) inward (on the graph), perhaps by tailoring a marketing program to this end. Or, the company might raise price from P to P*. Either approach would reduce AT&T's market share below the profit-maximizing level (where MC and MR intersect). This plan would not constitute a classic abuse of market power.

Regulatory and antitrust burdens are assumed to increase AT&T's operating cost sharply whenever output exceeds the level of Q*. Accordingly, a decision to price at P* exemplifies ex ante profit maximizing. Note, however, that industry data will not reflect this assumed increase in operating cost, so long as AT&T keeps its market share below the monopoly threshold.

If AT&T were to restrict quantity by raising price, then price P* would establish a market ceiling, which fringe carriers, including MCI and Sprint, would take as given. The market shares of these carriers would be determined in turn by output decisions reflecting each firm's unique cost and demand characteristics.

Pricing below P* by a fringe carrier could increase that carrier's market share (at least in the short run), and so might stimulate price competition. However, price cutting in long-distance markets might not be profit-enhancing. Industry demand is substantially price inelastic due to the absence of close substitutes for long-distance services at prevailing prices. %n8%n Accordingly, price cutting would not stimulate a firm's output enough to improve profits without a substantial, long-run shift in market share. The pursuit of market share through price cutting also could trigger a price war that could leave even the survivors worse off. Given these factors, fringe competitors might find it more sensible