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Externality control and endogenous market structure under uncertainty: The price vs. quantity dilemma

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  • Corato, Luca Di
  • Maoz, Yishay D.

Abstract

In a competitive industry where production entails a negative externality, a welfare-maximizing regulator considers, as control instruments, setting a cap on the industry output or levying an output tax. We embed this scenario within a dynamic setup where market demand is stochastic and market entry is irreversible. We firstly determine the industry equilibrium under each policy and then determine the cap level and the tax rate that maximize welfare in each case. We show that a first-best outcome can be achieved through the tax policy while the cap policy may only qualify as a second-best alternative.

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  • Corato, Luca Di & Maoz, Yishay D., 2023. "Externality control and endogenous market structure under uncertainty: The price vs. quantity dilemma," Journal of Economic Dynamics and Control, Elsevier, vol. 150(C).
    • Handle: RePEc:eee:dyncon:v:150:y:2023:i:c:s0165188923000465
    DOI: 10.1016/j.jedc.2023.104640
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    More about this item

    Keywords

    Investment; Uncertainty; Caps; Taxes; Competition; Externalities; Welfare;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • D62 - Microeconomics - - Welfare Economics - - - Externalities

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