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Entry into Regulated Monopoly Markets: The Development of a Competitive Fringe in the Local Telephone Industry*

Incumbent firms operating in today’s local telephone industry are beginning to face competition from new entrants. Using the dominant‐firm/competitive‐fringe framework and a recently constructed panel data set of local telephone markets, this paper provides an empirical analysis of the competitive transition underway in the U.S. local telephone industry. Of particular interest is the differential impact of economic regulation on the development of fringe competition in flocal telephone markets. Empirical results reveal that local telephone markets with price cap regulation have witnessed less net fringe entry and subsequently contain smaller competitive fringes during the time period studied. These findings imply that the widespread adoption of price cap regulation by state public utility commissions has contributed to the slow development of local telephone competition. To reconcile this surprising conclusion, a political economy explanation that details how state regulators have benefited from this regulatory decision is put forth and supported with empirical evidence.