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Prices versus Quantities in a Second-Best Setting

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  • Philippe Quirion

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Abstract

The choice between taxes and tradable permits has been independently analysed by two distinct research traditions. The first proceeds from Weitzman’s partial equilibrium stochastic model and concludes that a tax should be preferred if the marginal abatement cost curve is steeper than the marginal environmental benefit curve. The second utilises deterministic general equilibrium models with pre-existing distortionary taxes. It concludes that non-revenue-raising instruments (e.g., grandfathered tradable permits) are costlier than revenue-raising ones (e.g., a tax on every unit of pollution or auctioned permits). To build a bridge between these two traditions, we introduce in Weitzman’s model a positive cost of public funds due to pre-existing distortionary taxes. The tax admits a greater comparative advantage over the permits, as compared to Weitzman’s classical result. Then, we assume that the regulated industry blocks any proposal that poses it too high an expected burden. This may require a transfer to firms, in the form of freely-allocated permits or lump-sum tax rebate. It turns out that if this acceptability constraint is binding, then the comparative advantage of taxes over permits is still reinforced. Quantitatively, even if the marginal benefit function is 50% more steeply sloped than the marginal cost function, the price instrument should be preferred. We also compare the expected net benefit of these two instruments to a contingent instrument which leads to the ex post optimum. The superiority of the contingent instrument over the quantity one is higher than in first-best. Copyright Kluwer Academic Publishers 2004

Suggested Citation

  • Philippe Quirion, 2004. "Prices versus Quantities in a Second-Best Setting," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 29(3), pages 337-359, November.
  • Handle: RePEc:kap:enreec:v:29:y:2004:i:3:p:337-359
    DOI: 10.1007/s10640-004-5265-y
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    Cited by:

    1. Alain-Désiré Nimubona & Ujjayant Chakravorty & Andrew Leach, 2014. "The Search for Abatement Technologies in the Alberta Oil Sands," CESifo Working Paper Series 4781, CESifo Group Munich.
    2. Wood, Peter J. & Heindl, Peter & Jotzo, Frank & Löschel, Andreas, 2013. "Linking price and quantity pollution controls under uncertainty," ZEW Discussion Papers 13-025, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    3. Pezzey, John C.V. & Jotzo, Frank, 2010. "Tax-Versus-Trading and Free Emission Shares as Issues for Climate Policy Design," Research Reports 95049, Australian National University, Environmental Economics Research Hub.
    4. Vossler, Christian A. & Suter, Jordan F. & Poe, Gregory L., 2013. "Experimental evidence on dynamic pollution tax policies," Journal of Economic Behavior & Organization, Elsevier, vol. 93(C), pages 101-115.
    5. Villegas, Clara & Coria, Jessica, 2009. "Taxes, Permits and the Adoption of Abatement Technology under Imperfect Compliance," Working Papers in Economics 368, University of Gothenburg, Department of Economics.
    6. Rohling, Moritz & Ohndorf, Markus, 2012. "Prices vs. Quantities with fiscal cushioning," Resource and Energy Economics, Elsevier, vol. 34(2), pages 169-187.
    7. Frank Jotzo & John C. V. Pezzey, 2006. "Optimal Intensity Targets for Greenhouse Emissions Trading Under Uncertainty," Economics and Environment Network Working Papers 0605, Australian National University, Economics and Environment Network.
    8. Athanasios Kampas & Richard Horan, 2016. "Second-best pollution taxes: revisited and revised," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 18(4), pages 577-597, October.
    9. Fabio Antoniou & Nikos Tsakiris, 2016. "On the Informational Superiority of Quantities Over Prices in the Presence of an Externality," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 65(1), pages 227-250, September.
    10. Clara Villegas-Palacio & Jessica Coria, 2010. "On the interaction between imperfect compliance and technology adoption: taxes versus tradable emissions permits," Journal of Regulatory Economics, Springer, vol. 38(3), pages 274-291, December.
    11. Fischer, Carolyn & Laxminarayan, Ramanan, 2010. "Managing partially protected resources under uncertainty," Journal of Environmental Economics and Management, Elsevier, vol. 59(2), pages 129-141, March.
    12. Carlos Chávez & John Stranlund, 2009. "A Note on Emissions Taxes and Incomplete Information," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 44(1), pages 137-144, September.
    13. Gilbert E. Metcalf, 2009. "Designing a Carbon Tax to Reduce U.S. Greenhouse Gas Emissions," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 3(1), pages 63-83, Winter.
    14. Guy Meunier, 2015. "Prices vs. quantities in presence of a second, unpriced, externality," Working Papers hal-01242040, HAL.
    15. Alain-Désiré Nimubona & Andrew Leach, 2014. "Abatement Technology Search," Working Papers 1407, University of Waterloo, Department of Economics, revised Aug 2014.
    16. John K. Stranlund & Yakov Ben-Haim, 2006. "Price-Based vs. Quantity-Based Environmental Regulation under Knightian Uncertainty: An Info-Gap Robust Satisficing Perspective," Working Papers 2006-1, University of Massachusetts Amherst, Department of Resource Economics.
    17. Frank Jotzo & John C. V. Pezzey, 2005. "Optimal intensity targets for emissions trading under uncertainty (now replaced by EEN0605)," Economics and Environment Network Working Papers 0504, Australian National University, Economics and Environment Network.
    18. Susana Ferreira, 2007. "Trade Policy and Natural Resource Use: The Case for a Quantitative Restriction," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 37(2), pages 361-376, June.
    19. Ian A. MacKenzie, 2015. "Prices versus quantities with distributional rent seeking," Discussion Papers Series 548, School of Economics, University of Queensland, Australia.
    20. Pezzey, John C.V. & Jotzo, Frank, 2012. "Tax-versus-trading and efficient revenue recycling as issues for greenhouse gas abatement," Journal of Environmental Economics and Management, Elsevier, vol. 64(2), pages 230-236.
    21. repec:kap:pubcho:v:171:y:2017:i:1:d:10.1007_s11127-017-0401-8 is not listed on IDEAS

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