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Speed Limits and Private Racetracks on Game and Player

Speed Limits and Private Racetracks

Patrick Woods  //  April 11, 2008

Telecoms: susceptible to an equilibrium of natural monopoly?


o you've heard that Bell Canada is arranging data according to priority.

I have followed with interest this week a discussion in the forums on the topic: internet service providers throttling, or limiting the amount of bandwidth a subscriber can consume, depending on his traffic type. Particularly intriguing is the poll result within the thread, where 50% of respondents are unsure of their agreement with ISPs throttling bandwidth. Perhaps characterizing the economic forces at play will equip those who are uncertain with an intellectual framework to be less so. I submit that understanding the microeconomic choice of the consumer and firm helps one assess whether an ISP is operating in a competitive or monopolistic market. From such a framework, one might be able to better judge the motivations, and perhaps fairness, behind a specific ISP's throttling.

Regardless the competitive environment of an ISP, one who subscribes to its services does so under a similar construct: cost-benefit analysis. Succinctly, each consumer derives an unquantifiable amount of satisfaction — utility — from his purchase. Through a unique process, he must decide if such satisfaction is worth the expense. A common currency is simply a translator for his own utility function, and allows for mutually beneficial transactions. If, say, a gamer derives $45 of pleasure from a broadband subscription, pays $35, and it costs the involved firms $25 to supply the service, everybody wins.

Notably, the $10 of extra utility the consumer receives and the $10 profit to the firm are defined as consumer and producer surplus, respectively. Logically, this consumer would pay up to $44.99 and the firm supplies for as little as $25.01 an internet service. While neither the consumer nor producer knows each other's surplus, their behavior in a free market, namely price offerings and consumption, indicate as much. Numerous consumers have different surpluses, and numerous firms have unique offerings and varying operational costs. Economic equilibrium is achieved in such a noisy, imperfect marketplace as consumers and firms adjust their consumption and supply in an effort to maximize their own surplus, or utility.

It follows, then, that firms operating in a market with no competition will do all they can to capture $44.99. With no competition, there is little incentive to offer new products or services. Firms would rather harvest the producer surplus with certainty, day in, day out. A variety of circumstances can give rise to a single firm controlling a marketplace, but most frequent causes of monopolies involve barriers to entry. If the cost for a new firm to enter the market is too great (e.g., $50 per subscriber for two years), we have the economic status quo of a natural monopoly. When you think about it, it makes sense that there are not competing sewer companies, railroad lines running in parallel, or two power plants vying for your business by running separate sets of wires to your house.

So, given the investments in infrastructure necessary to run an ISP, is the industry susceptible to an equilibrium of natural monopoly? Are different markets in different states of competition? How do we assess as much, and how ought natural monopolies be controlled when the marketplace fails?

To avoid getting bogged down in economic or regulatory nuance, other examples may serve as catalysts for thought. Highways and water lines, for example, have similar industrial characteristics. It is very expensive to pave roads, to lay pipe, to lay fiber optic cable. Firms that bear such expenditure would not do so without just financial reward, yet left alone, the owners of fiber optic cable could become monopolists. Roads are public for a reason (and we curse toll roads who promised to repeal their fees decades ago), and so too are utilities municipalized.

When all consumers need is a single network, should the ownership of the physical network be in a single firm's hands? The implications are enormous: a single firm can act as a tollbooth, set speed limits, have less incentive to maintain an information superhighway if the toll captured is $44.99, et cetera.

How does a market balance network innovation and infrastructure investment, oftentimes created by private firms, with the risk of a natural monopoly taking hold? What do you think, reader? Are there any historical lessons to draw from?

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