Optimal Policy Instruments for Externality-Producing Durable Goods Under Time Inconsistency

Garth Heutel

No 17083, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: When consumers exhibit present bias and are time-inconsistent, the standard solution to market failures caused by externalities--Pigouvian pricing--is suboptimal. I investigate policies aimed at externalities for time-inconsistent consumers. Welfare-maximizing policy in this case includes an instrument to correct the externality and an instrument to correct the present bias. Either instrument can be an incentive-based policy or a command-and-control policy. Calibrated to the US automobile market, simulation results from a model with time-inconsistent consumers suggest that the second-best gasoline tax is 18%-30% higher than marginal external damages. These simulations also suggest that social welfare is maximized with a gasoline tax set about equal to marginal external damages and a fuel economy tax that increases the price of an average non-hybrid car by about $750-$2200 relative to the price of an average hybrid car.

JEL-codes: D03 Q48 Q58 (search for similar items in EconPapers)
Date: 2011-05
New Economics Papers: this item is included in nep-cmp and nep-reg
Note: EEE PE
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Citations: View citations in EconPapers (22)

Published as " How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shock s . " Review of Economic Dynamics , Vol. 15, No. 2 (April 2012), 244 - 264.

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Working Paper: Optimal Policy Instruments for Externality-Producing Durable Goods under Time Inconsistency (2010)
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