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|Oil and gas together are the most important energy sources consumed in the United States. In 1983, 67% of total energy consumption was represented by these two resources (43% was oil and 25% natural gas), while coal accounted for only 23% of U.S. energy use. All other sources (hydroelectric, nuclear, geothermal, wood and other waste products) accounted for only 10% (U.S. Department of Energy, 1983, p. 1). In this chapter we address the issue of regulation in the oil and natural gas sectors of the U.S. energy industry. In addition, we analyze the cartel characteristics of the Organization of Petroleum Exporting Countries (OPEC). If OPEC is an effective cartel, then U.S. oil as well as substitute energy prices, production, and consumption will be affected by cartel action. Further, as the nation learned in the 1970s, major changes in oil prices produced major disturbances in other sectors of the U.S. and world economies. Consequently, it is important to determine whether the roughly ten-fold increase in nominal prices that occurred in the 1970s was the result of cartel action, the result of normal economic forces adjusting to the fact that the world was running out of cheap oil, or some combination of the two. Furthermore, the presence of OPEC- associated oil price increases is related to regulations that were imposed on the energy sector during the decade of the 70s. THE RATIONALE FOR GOVERNMENT INTERVENTION Economists have traditionally judged the state of an economy to be efficient if it is impossible to improve the welfare of any one member of society without harming someone else. Any economy that satisfies this condition is said to be Pareto efficient, after the Italian economist Vilfredo Pareto who first gave rigorous attention to such questions (see Chapter 4.10). It is easy to see why an economy that fails to satisfy this condition could not be efficient; by definition, it would be possible to alter the allocation of resources in a way that improves everyone's welfare.' Much of the appeal of this weak efficiency criterion is that it avoids comparisons of levels of well being among different individuals. The cost of such generality, however, is that in any given economic system a wide array of different Pareto efficient states will typically be attainable. In the simple Robinson Cursoe economy of the undergraduate textbook, for example, efficiency could just as easily be attained in the case where most of the island's resources are owned by Friday as in the case where they are under Crusoe's control. However, the distribution of welfare among the two inhabitants would obviously be quite different in the two situations. Such equity issues cannot be settled on objective or scientific grounds. To decide which distribution of welfare is socially "best" an explicit value judgment is needed. It is useful to keep in mind the preceding distinction between efficiency and equity issues when analyzing the role of government in a market economy. Decentralized market processes will not necessarily result in a distribution of welfare that society considers just. For this reason a potential role for government lies in the redistribution of income among individuals. In some circumstances, however, market pro-|