Deregulation, Market Power, and Prices: Evidence from the Electricity Sector

Abstract

When deciding whether to introduce market competition in a regulated industry, a regulator faces an important tradeoff. Market-based prices can provide incentives to allocate resources more efficiently and reduce costs, but the presence of market power may lead to increased markups. We construct a novel dataset on electricity generation, wholesale transactions, and retail sales to investigate the impact of deregulation in the context of the U.S. electricity sector. We find that the higher markups charged by generation companies more than offset the efficiency gains, leading to higher wholesale prices. Downstream, incumbent utility retail prices rose one-for-one with the increase in variable costs of procurement, while the introduction of alternative retail suppliers generated modest retail markups for some customers. These results highlight the role of market power in deregulated markets, and show that consumers may prefer regulated prices to market-based prices when markets are not perfectly competitive.

Keywords: Deregulation, Market Power, Markups, Prices, Electricity

JEL Classification: L51, L94, D43, L13