[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

let us first review why competition may not be viable when average costs are
declining over the relevant range of output.
If two firms divide the market between them, each faces higher average costs
than if either one controlled the whole market. By undercutting its rival, a firm would
be able to capture the entire market and reduce its average costs. By the same token,
a natural monopolist knows that it can charge a price above its average cost without
worrying about entry. Rivals that might enter the market, trying to capture
some of the profits, know that the natural monopolist has lower costs because of its
larger scale of production, and so can always undercut them.
Even under these conditions, some economists have argued that a monopolist
would not in fact charge higher than average costs, because a rival could enter any
time and grab the whole market. Analysts have argued that in the software industry,
such a worry leads Microsoft to lower its prices. By keeping its prices lower
than it would if no potential rival could enter the market, Microsoft promotes the
wider use of its software. As people use programs such as Microsoft’s Word and
Excel, they become familiar with them and more reluctant to switch to something
new, thereby creating a greater obstacle for a new entrant to overcome. Similarly,
in small countries such as New Zealand, the threat that a large foreign firm could enter
the market and take it over if the local monopoly charged above average costs
restrains the monopoly’s ability to raise its prices. On this argument, all that is
required to keep prices low is potential competition.
Most economists are not so optimistic about the effectiveness of potential, as
opposed to actual, competition. They note that potential competition has not been
able to keep airline prices down in those markets in which actual competition is
limited to one or two carriers.
In the late 1970s and 1980s, many governments became convinced that competition,
however imperfect, might be better than regulation, and they began a process
of deregulation. Deregulation focused on industries such as airlines, railroads,
and trucking in which increasing returns to scale are limited. Recall that it is
increasing returns to scale that lead to declining average costs. Thus, reformers
believed that competition had a chance of succeeding in these industries. Government
also sought to distinguish parts of an industry where competition might
work from parts where competition was unlikely to be effective. In the telephone
industry, for example, competition among several carriers was strong for longdistance
telephone service, and there were few economies of scale in the production
of telephone equipment. Accordingly, regulation in these areas was reduced
or eliminated.
The virtues of competition have been realized, for the most part. Trucking—
where the arguments for government regulation seemed most suspect—was
perhaps the most unambiguous success story, as prices have fallen significantly.
Railroads appear more financially sound than they did under regulation. But coal
producers, who rely on railroads to ship their coal, complain that railroads have
used their monopoly power to charge them much higher tariffs.
Airline deregulation has become more controversial. After its initial success—
marked by new firms, lower fares, and more extensive routings—a rash of
bankruptcies has reduced the number of airlines. Many airports, including those
at St. Louis, Atlanta, and Denver, are dominated by one or two carriers, and
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