Prices versus Quantities with Policy Updating

Weitzman shows that the welfare advantage of price versus quantity regulation turns on the relative slopes of marginal costs and benefits when policy is set before uncertain shocks are known. Policy updating over time changes this result. Under intertemporally tradable quantity regulation, permit prices are determined by firms’ expectations about future policy updates, and the advantage of prices versus quantities instead turns on firms’ expectations of policy changes. If firms accurately predict policy changes and the government maximizes welfare, quantity regulation can achieve the first best. Price regulation, lacking an intertemporal link, cannot. The preference tilts back toward prices under more realistic assumptions where governments set policy inefficiently or firms imperfectly anticipate policy changes. In general, the advantage turns on information and expectations, not relative slopes. Given the prevalence of intertemporally tradable permits and policy updates, our results suggest new considerations in the choice between price and quantity regulation.