Correlated Uncertainty and Policy Instrument Choice

Abstract For two decades, environmental economists have generally maintained that benefit uncertainty is irrelevant for choosing between price and quantity instruments, but that cost uncertainty matters, with the identity of the efficient instrument depending upon the relative slopes of the marginal benefit and cost functions. But, in the presence of simultaneous, correlated uncertainty, such policy instrument recommendations may be inappropriate. With plausible values of relevant parameters, the conventional identification of a price instrument will be reversed, to favor instead a quantity instrument. The opposite reversal—from the choice of a quantity instrument to a price instrument—seems less likely to occur.

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