South-Western College Publishing - Economics  
Deregulation Doesn't Make Electricity Market More Competitive
Topic Monopoly ; Market Failure, Regulation and Public Choice
Key Words electricity, deregulation, price, competition.
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Reference ID: A152817721

News Story After deregulation, prices in the trucking, airlines and long-distance telephone markets all fell, some more significantly than others. But ten years after opening up the utilities market to competitive forces, no such price reductions have appeared. Why?

Some states have seen decreases in energy prices, but they have been artificial changes, such as price freezes, caps on price increases, etc. Artificial means were used to rein in price increases. Other states are seeing benefits from increases in nuclear power generation, resulting in lower overall energy prices. But for 60% of U.S. electrical consumers, no price relief is in sight. If increased competition should reduce price, why has price increased rather than fallen?

Part of the problem is that, while the system may have become more competitive, it didn't become more efficient because market incentives for efficiency were notably absent. First, under the old system, power companies owned both the generating plants and the power distribution networks. Under the new (deregulated) system, the power companies distribute the power, but don't necessarily own the generating plants. As a result, the power companies have to purchase their power from the separate companies that bought the generating plants, possibly at prices higher than the original costs they incurred while both running the generating plants and distributing the power over the networks. Second, some state power companies purchase electricity from the same few plants from whom they had always bought their power-at the same old prices, which reduces competition. Finally, the old one-price system in place during regulation was never eliminated. Under the old regulations that the industry put in place and the federal regulators approved, utilities would pay the highest price in the bidding process, not the lowest-an inducement to encourage utilities to engage in more research and development. This same highest-bid price system remains in place. Ultimately, a competitive market never arose out of the deregulatory dust. Buying at the highest offer?? No wonder prices haven't fallen!

Investors also contribute to the problem. Some purchased power plants and then turned around and sold power to utility companies for more than it used to cost the utility to run the power plants themselves.

It appears that, to make a market competitive, we have to do more than just call it competitive.

Discussion Questions:
1. Draw a graph of a natural monopoly in SR equilibrium. Now allow competition to ensue. What should happen to the price? Why? Explain graphically.
2. What are the incentive effects of a "maximum bid" contract? Will cost be controlled? Why or why not?
3. Outline some of the non-competitive aspects of utilities, as identified in this article. How do those compare with, say, the competitive aspects of long-distance telephone service?
Multiple Choice/True False Questions:
1. Under regulation, a utility would be allowed to earn a(n) --------- profit.

  1. economic
  2. normal
  3. opportunity
  4. negative
2. True/False. Utilities are considered "natural monopolies" because they can serve the market alone more efficiently and at a lower price than several firms.

3. Under deregulation, the market price of electricity should have , and the market quantity should have -------- .

  1. Increased; increased.
  2. Increased; decreased.
  3. Decreased; increased.
  4. Decreased; decreased.
Source Johnston, David Cay. "Competitive Era Fails to Shrink Electric Bills." The New York Times. October 15, 2006.
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