Correct (and Misleading) Arguments for Using Market Based Pollution Control Policies.

by Larry Karp

- Multiple investment equilibria and "regulatory uncertainty" arise when firms anticipate command and control policies. Market based policies eliminate this uncertainty. Command and control policies cause firms to imitate other firms’ investment decisions, leading to similar costs and small potential efficiency gains from trade. Market based policies induce firms to make different investment decisions, leading to different costs and large gains from trade. This paper imbeds the regulatory problem in a "global game" and show that the unique equilibrium to that game is constrained socially optimal.

Karp, L. (2008). "Correct (and Misleading) Arguments for Using Market Based Pollution Control Policies." Department of Agricultural & Resource Economics, UCB. CUDARE Working Paper 1063, Aug 2008.