Abstract:

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