The Allocative Cost of Price Ceilings: Lessons to Be Learned from the US Residential Market for Natural Gas

50 Pages Posted: 19 May 2008

See all articles by Lucas W. Davis

Lucas W. Davis

University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER)

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas; Centre for Economic Policy Research (CEPR)

Date Written: February 2007

Abstract

Following a Supreme Court decision in 1954, natural gas markets in the U.S. were subject to 35 years of intensive federal regulation. Several studies have measured the deadweight loss from the price ceilings that were imposed during this period. This paper concentrates on an additional component of welfare loss that is rarely discussed. In particular, when there is excess demand for a good such as natural gas for which secondary markets do not exist, an additional welfare loss occurs when the good is not allocated to the buyers who value it the most. We quantify the overall size of this allocative cost, its evolution during the post-war period, and its geographical distribution, and we highlight implications of our analysis for the regulation of other markets. Using a household-level, discrete-continuous model of natural gas demand we estimate that the allocative cost averaged $8.1 billion annually in the U.S. residential market for natural gas during 1950-2000, effectively doubling previous estimates of the total welfare losses from natural gas regulation. We find that these allocative costs were borne disproportionately by households in the Northeast, Midwest, and South Atlantic states. Costs were largest in New York, Pennsylvania, and Massachusetts with 70% of all costs borne by the ten states affected most.

Keywords: Allocative cost, deadweight loss, natural gas, price ceiling, regulation

JEL Classification: D45, L51, L71

Suggested Citation

Davis, Lucas W. and Kilian, Lutz, The Allocative Cost of Price Ceilings: Lessons to Be Learned from the US Residential Market for Natural Gas (February 2007). CEPR Discussion Paper No. DP6142. Available at SSRN: https://ssrn.com/abstract=1133787

Lucas W. Davis (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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