Price and quantity regulation in general equilibrium

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26 Scopus citations

Abstract

We consider a general equilibrium model with a production externality (e.g. pollution), where the regulator does not observe firm productivity shocks. We examine quantity (permit) regulation and price (tax) regulation. The quantity of permits issued by the regulator are independent of the productivity shock, since shocks are unobserved. Price regulation implies use of the regulated input is an increasing function of the productivity shock because firms take advantage of a good productivity shock by increasing input use. Thus price regulation generates higher average, but more variable, production. Therefore, we show that in general equilibrium the relative advantage of quantity versus price regulation depends not only on the slopes of marginal benefits and costs, but on general equilibrium effects such as risk aversion. The general equilibrium effects are often more important than the slopes of the marginal benefits and cost curves. In the simplest model, a reasonable risk aversion coefficient implies quantity regulation generates higher welfare regardless of the benefit function.

Original languageEnglish (US)
Pages (from-to)36-60
Number of pages25
JournalJournal of Economic Theory
Volume125
Issue number1
DOIs
StatePublished - Nov 1 2005

Keywords

  • Asymmetric information
  • Choice of instruments
  • Pollution control
  • Tax regulation
  • Tradeable permits

ASJC Scopus subject areas

  • Economics and Econometrics

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