The role of stocks and shocks concepts in the debate over price vs. quantity
Working Paper 43
Two simple examples are constructed 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.
The stock pollutant argument is considered dispositive, so that the preference for price controls is categorical.
It is shown that this argument can only be true if the uncertainty about cost is a special form: all shocks are transitory. It is shown 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.
The simplicity of the examples and the solutions is a major element of the contribution here. The examples are readily accessible and the comparison of results under the alternative assumptions of transitory and permanent shocks is stark.
John E. Parsons and Luca Taschini