Working Paper: NBER ID: w13991
Authors: Richard G. Newell; William A. Pizer
Abstract: Seminal work by Weitzman (1974) revealed prices are preferred to quantities when marginal benefits are relatively flat compared to marginal costs. We extend this comparison to indexed policies, where quantities are proportional to an index, such as output. We find that policy preferences hinge on additional parameters describing the first and second moments of the index and the ex post optimal quantity level. When the ratio of these variables' coefficients of variation divided by their correlation is less than approximately two, indexed quantities are preferred to fixed quantities. A slightly more complex condition determines when indexed quantities are preferred to prices. Applied to climate change policy, we find that the range of variation and correlation in country-level carbon dioxide emissions and GDP suggests the ranking of an emissions intensity cap (indexed to GDP) compared to a fixed emission cap is not uniform across countries; neither policy clearly dominates the other.
Keywords: Indexed Regulation; Climate Change Policy; Emissions Cap; Economic Activity
JEL Codes: C68; D81; H41; Q54; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| coefficient of variation of the index / coefficient of variation of the optimal quantity level < 2 (C43) | indexed quantities are preferred to fixed quantities (C43) |
| strong correlations between output and emissions and relatively low output variance (E23) | countries tend to favor indexed quantities (C43) |
| low correlation or high output variance (C10) | countries tend to favor fixed quantities (F14) |
| marginal benefits steep relative to marginal costs (D61) | indexed quantities can outperform fixed quantities (C69) |