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The Role of Stocks & Shocks Concepts in the Debate Over Price vs. Quantity

Environmental and Resource Economics, Vol. 55, No. 1, 2013

MIT CEEPR Working Paper No. WP-2011-002

32 Pages Posted: 14 Mar 2011 Last revised: 12 Oct 2013

John E. Parsons

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Luca Taschini

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment

Date Written: October 26, 2011

Abstract

Many economists and policy makers have long favored the use of a price instrument to control 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 is consistent with this view, the later literature is less categorical. It showed that the choice between a price or quantity control depends, in part, upon the assumption on the dynamic structure of cost uncertainty. Temporary shocks to abatement cost favors 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 yet received wide currency among economists. We analyze the problem in an alternative setting and reproduce the result that temporary shocks favor use of a price control while permanent shocks favor use of a quantity control. Our contribution is the simplicity of the model and the accessibility of the results, which reinforce the critical role played by the assumed structure of uncertainty.

Keywords: Cap & Trade, Permanent Shocks, Tax, Transitory Shocks

JEL Classification: H23, Q28, Q50, Q58

Suggested Citation

Parsons, John E. and Taschini, Luca, The Role of Stocks & Shocks Concepts in the Debate Over Price vs. Quantity (October 26, 2011). Environmental and Resource Economics, Vol. 55, No. 1, 2013; MIT CEEPR Working Paper No. WP-2011-002. Available at SSRN: https://ssrn.com/abstract=1784356 or http://dx.doi.org/10.2139/ssrn.1784356

John E. Parsons

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~jparsons/

Luca Taschini (Contact Author)

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://personal.lse.ac.uk/TASCHINL/Luca_Taschini.html

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