Working Paper: NBER ID: w9283
Authors: Roberton C. Williams III
Abstract: This paper extends Weitzman's (1974) seminal paper comparing price and quantity instruments for regulation to consider a third option: tradable quantity regulations, such as tradable permits. Contrary to what prior work has suggested, fixed quantities may be more efficient than tradable quantities if the regulated goods are not perfect substitutes, even when trading ratios are based on the ratio of expected marginal benefits between goods, not simply one-for-one. Indeed, when benefits are independent across goods, or when the goods are complements, tradable quantities are never the most efficient instrument. This theory is applied to dynamic pollution problems, and suggests that permit banking should be allowed for stock pollutants, but not for flow pollutants. These results indicate that many regulations, including the current sulfur dioxide trading program and proposed greenhouse gas regulations, are inefficient.
Keywords: tradable permits; regulation; environmental economics
JEL Codes: L51; D81; Q2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed quantities (C69) | efficiency (D61) |
| tradable quantities (F10) | efficiency (D61) |
| goods not perfect substitutes (D43) | fixed quantities more efficient than tradable quantities (C69) |
| marginal benefits independent (D61) | efficiency of tradable quantities diminishes (D61) |
| permit banking allowed for stock pollutants (G18) | optimal regulatory practices (L51) |
| permit banking not allowed for flow pollutants (E50) | current regulations may not align with optimal regulatory practices (L51) |