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Prices versus quantities in the presence of a second, unpriced, externality

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  • Guy Meunier

Abstract

This paper analyzes whether the presence of a second unregulated externality influences the choice between a price and a quantity instrument to address an externality. The author studies a situation in which two goods jointly generate an externality but only one of them is regulated. The two instruments differ because of the presence of uncertainty regarding the private value of the two goods. To ignore the unregulated good and apply Weitzman's classical result on the comparison of the slopes of marginal benefit and cost could be misleading because of the randomness of the unregulated good's quantity. Beside the relative slope of the marginal damage, the substitutability and the distribution of shocks play a role in the comparison. If there is a “cocktail effect” and the regulated and unregulated goods' quantities are negatively correlated, which occurs if they are substitutes, this reinforces the appeal of a price instrument. Furthermore, if the two goods are weak substitutes with correlated demands, the variance of the quantity of the unregulated good is larger under a quota than a tax, which further reinforces the appeal of the tax instrument.

Suggested Citation

  • Guy Meunier, 2018. "Prices versus quantities in the presence of a second, unpriced, externality," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 20(2), pages 218-238, April.
  • Handle: RePEc:bla:jpbect:v:20:y:2018:i:2:p:218-238
    DOI: 10.1111/jpet.12250
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    Cited by:

    1. Nikula Harri, 2020. "Entry, exit, and instrument choice in environmental regulation," Working Papers 2026, Tampere University, Faculty of Management and Business, Economics.
    2. Nikula Harri, 2020. "Voluntary opt-in provision and instrument choice in environmental regulation," Working Papers 2027, Tampere University, Faculty of Management and Business, Economics.
    3. Nikula Harri, 2020. "Instrument choice in the case of multiple externalities," Working Papers 2028, Tampere University, Faculty of Management and Business, Economics.
    4. Qinglong Wang & Jiale Huang & Xian Zhang & Weina Qin & Huina Zhang & Yani Dong, 2022. "Climate Change and Human Response to Sustainable Environmental Governance Policy: Tax or Emissions Trading?," Sustainability, MDPI, vol. 14(15), pages 1-13, August.

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