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Introduction

5

considered along with the problems accompanying the restructuring of regulated markets in California.

If large producers have market power and are able to set prices, they can make monopoly profits. A classic example of this market failure is the Organization of Petroleum Exporting Countries (OPEC), which we discuss in chapter 6. We include both the history of OPEC as well as models to explain OPEC behavior. Since OPEC cannot control non-OPEC production, it will be treated as a dominant firm, rather than a monopoly; however, since OPEC is not a monolith but is comprised of 11 different countries, some of their differences will be noted as well.

With deregulation, institutional arrangements or governance structures in markets are likely to evolve. Such structures include spot purchases, long-term contracts, and vertical integration. Transaction-cost economics suggests that the market structure that survives is the one that minimizes transaction costs. Market governance is determined by a number of factors including the specificity of assets in the industry. For example, a pipeline is a very specific asset transporting a particular good from one predefined place to another, whereas a semi-truck is much less specific and can transport a variety of different goods to and from a variety of places. Market governance is also influenced by the amount of uncertainty and the frequency of transactions, all of which influence transaction costs. In chapter 7, we introduce transaction cost economics and apply it to changes in the U.S. natural gas markets.

Energy production, transport, and consumption produce a variety of pollutants. Often such pollutants affect others besides the producers of the pollutants. For example, when the Exxon Valdez went aground in Prince William Sound, Alaska, spilling millions of barrels of oil, Exxon lost money but wildlife, fishermen, and others external to the producers and consumers of the product were affected negatively as well. Thus, pollutants are called negative externalities. Since the producer or private decision-maker does not take into account these costs, which are external to them, private markets will not allocate energy efficiently. Therefore governments have stepped in with laws and policies that have been undertaken in response to externalities such as pollution. A review these policies will be presented in chapter 8.

Another externality comes from public goods: A good from which people cannot be excluded (non-excludability) and one person’s consumption does not reduce another person’s consumption (non-rivalrous). The classic example is a lighthouse: Anyone in the vicinity can look at it, and one person looking at it does not generally restrict the ability of another to look at it. If, in making a private decision to produce such a good, an individual only takes his own satisfaction or utility into account, too little of the good will likely be produced. Further, if one cannot be excluded from consumption, each consumer will want someone else to pay for the good (the free-rider problem). Both effects cause a public good to be under-provided by the private market.

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