Cost Heterogeneity and the Potential Savings from Market-Based Policies

Policy makers and policy analysts are frequently faced with situations where it is unclear whether market-based instruments hold real promise of reducing costs, relative to conventional command-and-control approaches. We develop rules-of-thumb that can be employed with minimal amounts of information to estimate the potential cost savings associated with market-based policies, with an application to the environmental policy realm. Our hope is that these simple formulae can aid policy analysts and policy makers in the early stages of exploring alternative policy instruments by helping them identify approaches that merit greater attention and more detailed analysis. We illustrate the use of the rules-of-thumb with an application to nitrogen oxides control in the eastern United States.