Regulating stock externalities under uncertainty

Using a simple analytical model incorporating benefits of a stock, costs of adjusting the stock, and uncertainty in costs, we uncover several important principles governing the choice of price-based policies (e.g., taxes) relative to quantity-based policies (e.g., tradable permits) for controlling s...

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Bibliographic Details
Published in:Journal of environmental economics and management 2003-03, Vol.45 (2), p.416-432
Main Authors: Newell, Richard G., Pizer, William A.
Format: Article
Language:English
Subjects:
Climate change
Costs
Economic models
Economic theory
Economics
Environment
Environmental economics
Externalities
Externality
Policy
Prices
Quantities
Regulation
Stock
Stocks
Studies
Taxes
Tradable permits
Uncertainty
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Summary:Using a simple analytical model incorporating benefits of a stock, costs of adjusting the stock, and uncertainty in costs, we uncover several important principles governing the choice of price-based policies (e.g., taxes) relative to quantity-based policies (e.g., tradable permits) for controlling stock externalities. As in Weitzman (Rev. Econom. Stud. 41(4) (1974) 477), the relative slopes of the marginal benefits and costs of controlling the externality continue to be critical determinants of the efficiency of prices relative to quantities, with flatter marginal benefits and steeper marginal costs favoring prices. But some important adjustments for dynamic effects are necessary, including correlation of cost shocks across time, discounting, stock decay, and the rate of benefits growth. Applied to the problem of greenhouse gases and climate change, we find that a price-based instrument generates several times the expected net benefits of a quantity instrument.
ISSN:0095-0696
1096-0449
DOI:10.1016/S0095-0696(02)00016-5