We extend the standard ‘Prices vs. Quantities’ framework to cover two independent and identical jurisdictions, A and B. Both jurisdictions set a price or quantity to maximize their own expected welfare conditional on the instrument type and amount chosen by the other jurisdiction. With iid uncertainty, a dominant strategy of both jurisdictions is to choose a price instrument when the slope of marginal benefit is less than the slope of marginal cost and a quantity instrument when the condition is reversed. With n countries, if the slope of marginal benefit is equal to the slope of marginal cost, the welfare cost at the equilibrium in which countries coordinate on prices is higher, by a factor of n, than the welfare cost at the equilibrium in which countries coordinate on quantity. By extending the standard ‘Prices vs. Quantities’ criterion from the basic choice framework to a strategic setting, we allow the choice of policy type and amount to take into account the free-riding by other jurisdictions and discover the welfare benefit of coordination on quantities.

JEL Codes: C7, D8, F5, H21, Q28, Q58

Keywords: prices versus quantities, regulatory instruments, pollution, climate change

%G eng %0 Generic %D Working Paper %T Prices or Quantities Dominate Banking and Borrowing %A Martin L. Weitzman %X

The possibility of intertemporal banking and borrowing of tradeable permits is often viewed as tilting the various policy debates about optimal pollution control instruments toward favoring such time-flexible quantities. The present paper shows that this view is incorrect for a natural dynamic extension of the original 'prices vs. quantities' information structure that allows the firms to know and act upon the realization of uncertain future costs two full periods ahead of the regulators. For any given circumstance, this paper shows that either a fixed price or a fixed quantity is superior in expected welfare to time-flexible banking and borrowing. Furthermore, the standard original formula for the comparative advantage of prices over quantities contains sufficient information to completely characterize the regulatory role of intertemporal banking and borrowing. The logic and implications of these results are analyzed and discussed.

JEL Codes: Q50, Q51, Q52, Q54, Q58

Keywords: prices, quantities, prices versus quantities, regulatory instruments, pollution, climate change

%G eng