mic industry, as well as how the emergence of competition is undermining these regulatory rationales. 1. Natural Monopoly One of the bedrock assumptions of telecommunications policy is that local tele- phone networks are natural monopolies, primarily because of the large fixed cost investments associated with establishing telephone switches and the network of wires needed to transmit telephone calls. Natural monopoly represented one of the central justifications for early regulatory efforts in the 1920s as well as the reg- ulatory scheme created by the Communications Act of 1934 (U.S. Senate 1921b, 1934a, 1934b). Indeed, the entire telephone network was generally regarded as a natural monopoly until the 1960s.9 Even after the FCC began to use regulation and the breakup of AT&T to promote competition in services complementary to local telephony, such as CPE, long distance, and information services, policymakers 9 See Faulhaber (1987); Huber et al. (1999). Networks in Telecommunications continued to believe that local telephone networks remained natural monopolies, largely by virtue of the high fixed costs associated with laying the wires needed local distribution possible. 10 As noted in Chapter 4, unless products are differentiated, the presence of economies of scale that are not exhausted over the entire range of industry output is a sufficient condition for natural monopoly. It was not until the enactment of the Telecommunications Act of 1996 that policymakers began attempting to promote local competition in earnest. A close analysis of the cost structure belies any suggestion that local telephone service constituted a natural monopoly during the early years of the telephone industry. The primary source of diseconomies of scale was switching. 11 Initially, an operator at a switchboard made telephone connections manually. Switching was relatively simple SO long as the number of subscribers connected to any particular exchange was relatively small. Increases in the number of subscribers eventually required the in