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The role of stocks and shocks concepts in the debate over price vs. quantity

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  • John E. Parsons
  • Luca Taschini
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    Abstract

    Many economists and policy makers have long favored the use of a price instrument tocontrol greenhouse gases because they are a stock pollutant and as such the marginal benefit of abatement is relatively flat. While the early literature on the problem isconsistent with this view, the later literature is less categorical. It showed that thechoice between a price or quantity control depends, in part, upon the assumptionon the dynamic structure of cost uncertainty. Temporary shocks to abatement costfavors the use of a price control, while permanent shocks favor a quantity control.Unfortunately, the importance of this assumption to the optimal choice has not yetreceived wide currency among economists. We analyze the problem in an alternativesetting and reproduce the result that temporary shocks favor use of a price controlwhile permanent shocks favor use of a quantity control. Our contribution is thesimplicity of the model and the accessibility of the results, which reinforce the criticalrole played by the assumed structure of uncertainty.

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    File URL: http://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/02/WP43_price-quantity-greenhouse-gas.pdf
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    Bibliographic Info

    Paper provided by Grantham Research Institute on Climate Change and the Environment in its series Grantham Research Institute on Climate Change and the Environment Working Papers with number 43.

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    Date of creation: Mar 2011
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    Handle: RePEc:lsg:lsgwps:wp43

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    1. M. L. Weitzman, 1973. "Prices vs. Quantities," Working papers 106, Massachusetts Institute of Technology (MIT), Department of Economics.
    2. Stavins, Robert N., 1996. "Correlated Uncertainty and Policy Instrument Choice," Journal of Environmental Economics and Management, Elsevier, vol. 30(2), pages 218-232, March.
    3. Hoel, Michael & Karp, Larry, 2002. "Taxes versus quotas for a stock pollutant," Resource and Energy Economics, Elsevier, vol. 24(4), pages 367-384, November.
    4. Newell, Richard G. & Pizer, William A., 2003. "Regulating stock externalities under uncertainty," Journal of Environmental Economics and Management, Elsevier, vol. 45(2, Supple), pages 416-432, March.
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