Tuesday, September 6, 2016

Special Access Prices Are Not Evidence of Market Power, Phoenix Center Argues

Prices in the U.S. special access market (business data services) actually do not actually indicate there is market power, argues George Ford, Phoenix Center for Advanced Legal and Economic Public Policy Studies chief economist.

Why is that important? The U.S. Federal Communications Commission argues there is market power exercised, which it believes explains prices in the special access market. Ford argues that is an unsupported assumption.

If market power is a “bad thing” because it leads to higher prices than would occur in a competitive market, one has to ask what the competitive price might be, as part of the determination of whether market power exists, says Ford.

The answer cannot be “marginal cost of providing the next unit of output,” as that ignores all the sunk costs in the full network.

Telecom markets tend to be oligopolistic, so the assumption of “a perfectly-competitive market” tends to fail, as a useful analytical assumption.

Instead, Ford argues, the relevant “competitive price” in real-world markets is the price that arises from the maximum level of competition supported by the demand- and supply-side conditions of the actual market.

In other words, if market conditions are such that only two firms can profitably offer service, then the noncollusive duopoly price is the “competitive price.”

Firms enter when it is profitable to do so, and they do not enter when it is not profitable to do so. If a market has only two dominant providers, and entry by other firms is lawful, there probably is a reason only two firms operate.

There are real policy implications. “Telecommunications markets are often served by relatively few firms not because of some random process or poor public policy, but because the size of the market is small relative to the fixed cost of providing service (or, equivalently, the fixed costs are high relative to the size of market demand),” says Ford. “If only two firms can profitably serve a market, it is of no value to lament the fact there are not ten firms doing so.”

“Nor is sensible to use the equilibrium price for five firms as a regulatory benchmark in a market that can be served by only two firms,” Ford argues. “If the five-firm price was meaningful, then there would be five firms in the market.”

In other words, the determinants of price are likewise the determinants of the number of firms.

“The lack of entry is not an indicator of market power, it is an indicator that entrants do not believe there is sufficient excess profit in the market to justify the capital costs to serve it,” Ford notes.

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