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Discussion Papers no. 755

Prices vs. quantities with endogenous cost structure

This paper derives a criterion comparing prices versus tradable quantities in terms of expected welfare, given uncertainty, optimal policy and endogenous cost structure.

Authorities often lack information for efficient regulation of the commons. This paper derives a criterion comparing prices versus tradable quantities in terms of expected welfare, given uncertainty, optimal policy and endogenous cost structure. I show that one cannot determine which regulatory instrument that induces the highest expected welfare based on the relative curvatures of the cost and benefit functions alone. Furthermore, optimal policy involves different production (or price) targets across the regulatory instruments, and does not equalize marginal costs and expected marginal benefits under prices. The reason is that firms choose a cost structure which induces exaggerate fluctuations in consumption of the public good under prices, and the regulator has to compensate for this when determining optimal policy. Because no such negative externality arises under quantities, the relative performance of prices is deteriorated. A numerical illustration suggests significant impact. Finally, either regulatory instrument may induce the highest technology investment levels.

About the publication

Title

Prices vs. quantities with endogenous cost structure

Author

Halvor Briseid Storrøsten

Series and number

Discussion Papers no. 755

Publisher

Statistics Norway

Topic

Discussion Papers

ISSN

1892-753X

Number of pages

42

Language

English

About Discussion Papers

Discussion papers comprise research papers intended for international journals and books. A preprint of a Discussion Paper may be longer and more elaborate than a standard journal article as it may include intermediate calculations, background material etc.

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