... The entire city (aside from those using wireless phone
> service) are forced to use the services of the local telephone company.
> In past years, local internet service providers have sprung up -- only
> to be bought out by the local telephone company.
I can't answer your question of whether this is allowable or not.
However, in general terms, this is the free marketplace at work, and the goal of deregulation and divesture was a free marketplace.
In some places a free market means vigorous competition. However, if there are not enough customers support a volume business, businesses will have no interest to serve that market and you have your situation.
You also have the situation where one company buys up others which also is perfectly legal.
In other words, if you're in the middle of Manhattan you'll find numerous choices of restaurants within a few square blocks of yourself. If you're in some town of 1,000 people, you'll find likely one restaurant, take it or leave it.
You may have an anti-trust issue with your phone company buying up every potential competitor. But I don't know how anti trust law works these days or how it applies to this business.