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

When deciding whether to introduce market competition into 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 use a detailed dataset on electricity transactions to investigate the impact of market-based deregulation in the context of the U.S. electricity sector. We find that the increase in markups dominates despite modest efficiency gains, leading to higher consumer prices. Deregulation does not necessarily reduce prices and improve consumer welfare. Thus, regulated prices may be preferred to market-based prices when firms are capable of exerting market power.