Electricity restructuring offers the potential for more efficient production and investment, but may create the opportunity for producers to exercise market power. Oligopolists may cause deadweight loss in wholesale electricity markets, even when demand is perfectly inelastic, by inducing cross-firm production inefficiencies. This study estimates the environmental implications of production inefficiencies attributed to market power in the Pennsylvania, New Jersey, and Maryland electricity market.
    Air pollution fell substantially during 1999, the year in which both electricity restructuring and new environmental regulation took effect. I measure production inefficiencies by comparing observed behavior with estimates of production in a competitive market. During the period studied, actual production costs, including abatement costs, exceeded competitive estimates by 8%. Estimates of competitive production, which account for new environmental regulation, explain only 60% of the observed pollution reductions. The remaining 40% can be attributed to firms exercising market power. Given oligopoly behavior in product markets, I discuss the conditions under which environmental policy makers improve welfare with permit systems in comparison to pollution taxes.

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