The role of stocks and shocks concepts in the debate over price vs. quantity

John E. Parsons and Luca Taschini

No 43, GRI Working Papers from Grantham Research Institute on Climate Change and the Environment

Abstract: Many economists and policy makers have long favored the use of a price instrument tocontrol greenhouse gases because they are a stock pollutant and as such the marginal benefit of abatement is relatively flat. While the early literature on the problem isconsistent with this view, the later literature is less categorical. It showed that thechoice between a price or quantity control depends, in part, upon the assumptionon the dynamic structure of cost uncertainty. Temporary shocks to abatement costfavors the use of a price control, while permanent shocks favor a quantity control.Unfortunately, the importance of this assumption to the optimal choice has not yetreceived wide currency among economists. We analyze the problem in an alternativesetting and reproduce the result that temporary shocks favor use of a price controlwhile permanent shocks favor use of a quantity control. Our contribution is thesimplicity of the model and the accessibility of the results, which reinforce the criticalrole played by the assumed structure of uncertainty.

Date: 2011-03
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