Stocks and shocks: a clarification in the debate over price vs. quantity controls for greenhouse gases

John E. Parsons and Luca Taschini

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We construct two simple examples that help to clarify the role of a key assumption in the analysis of price or quantity controls of greenhouse gases in the presence of uncertain costs. Traditionally much has been made of the fact that greenhouse gases are a stock pollutant, and that therefore the marginal benefit curve must be relatively flat. This fact is said to establish the preference of a price control over a quantity control. The stock pollutant argument is considered dispositive, so that the preference for price controls is categorical. We show that this argument can only be true if the uncertainty about cost is a special form: all shocks are transitory. We show that in the case of permanent shocks, the traditional comparison of marginal benefits vs. marginal costs is mis-measured. The choice between quantity and price controls becomes ambiguous again and depends upon a more difficult measurement of marginal costs and benefits. The simplicity of the examples and the solutions is a major element of the contribution here. The examples are readily accessible and the comparison of results under the alternative assumptions of transitory and permanent shocks is stark.

Keywords: cap & trade; permanent shocks; tax; transitory shocks. (search for similar items in EconPapers)
JEL-codes: H23 Q28 Q50 Q58 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2011-03-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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