April 17, 2011

Stocks & Shocks: A Clarification in the Debate Over Price vs. Quantity Controls for Greenhouse Gases

by John E. Parsons and Luca Taschini

- 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. 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.

Parsons, J.E. and L. Taschini (2011). "Stocks & Shocks: A Clarification in the Debate Over Price vs. Quantity Controls for Greenhouse Gases." MIT CEEPR Working Paper No. WP-2011-002, Mar 2011.