Tradable Permits Versus Effluent Charges Under Cost Uncertainty and Fuel Price Volatility

Abstract

This paper compares price-based and quantity-based environmental regulation policies on efficiency grounds when the regulator is uncertain about the future price of fossil fuels and the firms' marginal abatement costs (MAC). In doing so, two key issues are considered. First, it investigates whether assuming complementarity between fossil fuels and emissions in the face of volatile oil price alters the Weitzman results. Secondly, it examines how the choice between permits and taxes is affected if innovation in the marginal abatement costs are unidirectional. With regards to the first issue. Weitzman's analysis remains intact. As for the second issue, it is found that uncertainty in the marginal abatement cost does not affect instrument choice. The paper thus provides new theoretical insights on the insignificant of the MAC uncertainty for the choice of market-based environmental policies when innovations in MAC are unidirectional.