Deregulation as a switch of regime: Price effects using a modified Hotelling rule

Abstract

Concern over rising energy prices has led to support for government intervention to regulate the price of domestic non-renewable energy resources. However, US policy makers appear to be looking more towards competition, rather than regulation, to decide who will provide energy resources and how these will be priced. This paper models possible dynamic price effects occasioned by the removal of a regulatory constraint. The analysis focuses on a government decision to eliminate binding price ceilings on a non-renewable (energy) substitute when the incumbent resource is monopolistically controlled (using deregulation of natural gas as an illustration). Under certain conditions it is shown that one will get continuity of marginal revenue and a fall in the world price following decontrol (the expiration of a patent or a decision to grant mineral rights on federal land). In general, however, the model suggests that both marginal revenue and prices will be discontinuous and that the discontinuity is likely to result in a fall in price.