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Indexed Regulation

  • Richard G. Newell
  • William A. Pizer

Seminal work by Weitzman (1974) revealed prices are preferred to quantities when marginal benefits are relatively flat compared to marginal costs. We extend this comparison to indexed policies, where quantities are proportional to an index, such as output. We find that policy preferences hinge on additional parameters describing the first and second moments of the index and the ex post optimal quantity level. When the ratio of these variables' coefficients of variation divided by their correlation is less than approximately two, indexed quantities are preferred to fixed quantities. A slightly more complex condition determines when indexed quantities are preferred to prices. Applied to climate change policy, we find that the range of variation and correlation in country-level carbon dioxide emissions and GDP suggests the ranking of an emissions intensity cap (indexed to GDP) compared to a fixed emission cap is not uniform across countries; neither policy clearly dominates the other.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13991.

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Date of creation: May 2008
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Publication status: published as Newell, Richard G. & Pizer, William A., 2008. "Indexed regulation," Journal of Environmental Economics and Management, Elsevier, vol. 56(3), pages 221-233, November.
Handle: RePEc:nbr:nberwo:13991
Note: EEE
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  1. Carolyn Fischer, 2003. "Combining rate-based and cap-and-trade emissions policies," Climate Policy, Taylor & Francis Journals, vol. 3(sup2), pages S89-S103, December.
  2. M. L. Weitzman, 1973. "Prices vs. Quantities," Working papers 106, Massachusetts Institute of Technology (MIT), Department of Economics.
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  4. Weitzman, Martin L, 1978. "Optimal Rewards for Economic Regulation," American Economic Review, American Economic Association, vol. 68(4), pages 683-91, September.
  5. Richard G. Newell & William A. Pizer, 2008. "Indexed Regulation," NBER Working Papers 13991, National Bureau of Economic Research, Inc.
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  18. Neuhoff, K. & von Hirschhausen, C., 2005. "Long-term vs. Short-term Contracts; A European perspective on natural gas," Cambridge Working Papers in Economics 0539, Faculty of Economics, University of Cambridge.
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  20. Knut K. Aase, 2004. "A Pricing Model for Quantity Contracts," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 71(4), pages 617-642.
  21. Robert N. Stavins, 1998. "What Can We Learn from the Grand Policy Experiment? Lessons from SO2 Allowance Trading," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 69-88, Summer.
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