on the costs of providing capacity to serve this incremental demand. To simplify matters, up to this point we have assumed that all inputs are variable, SO that the firm is able to adjust capacity flexibly without incurring adjustment costs. To give regulation the benefit of the doubt, the network firm is able to move along its long-run marginal cost function. Let C(Q) and MC(Q) be the network firm's long-run cost and marginal cost, respectively. Finally, suppose that incumbent network firms act as competitive firms that take retail prices as given. The network firm chooses output to maximize profit, maxQ pQ - C(Q + A), SO that network firms equate marginal cost of retail and wholesale access to the retail price: p = MC(Q + A). Thus, the representative supply curve of a network firm reflects the provision of both retail and wholesale services, Q=S(p) - A, Networks in Telecommunications MC(Q) D(p,p) + A D°(p) + - A Figure 5.3. The market demand for retail access given incremental demand for wholesale access A. where S(p) is the inverse of the marginal cost curve. Taking the regulated wholesale demand for capacity as given, the market-clearing retail price p** solves D(p*),p)+ A = S(p*)). Consider the case in which wholesale access shifts out total demand relative to initial demand, as shown in Figure 5.3. Total capacity requirements increase, Q** + A > Q*. If the incumbent firm's demand is less than or equal to its initial demand, it follows from p** > p* that Q**=D(p**, p) is strictly less than Q* * = D°(p*). What are the consequences of such an increase in capacity? All other things equal, particularly if the network firm maintains its quality of service, additional capacity requirements must be met by adding nodes and links to the network or by expanding the capacity of individual nodes and lines. As capacity increases, it may become necessary to change transmission technology, increasing the carrying capacity of switches and lines. The network firm might upgrade parts of the network to incorporate different te