Clean air regulation and heterogeneity in US gasoline prices

In order to improve public health in areas with air quality problems, the US Clean Air Act imposes a variety of federal regulations on gasoline, which have led to a proliferation of fuel blends known as "boutique fuels." More than 45 fuel blends are sold nationwide. We examine the effects of this program on wholesale gasoline prices. The methodological innovation in this study is the use of a regulatory distance measure as a proxy for measuring market power that arises from product differentiation. We find that Clean Air regulation increases gasoline prices by increasing the cost of refining, but more importantly, by creating regulatory "islands," it segments the market and increases the market power of firms. Our estimation controls for the potential endogeneity of the regulatory variables. We find that OLS techniques systematically underestimate the effect of regulation on gasoline prices. (c) 2007 Elsevier Inc. All rights reserved.