Price vs. Quantities with Multiple Countries

Abstract

What is the best policy to mitigate climate change and manage other multilateral public goods? To answer this question, this paper examines a policy-making game among several countries. Governments choose both a policy's intensity (i.e., how much price or how much quantity) and a policy's type: price or quantity (e.g., carbon tax or emissions quota). The analysis uncovers a novel form of inefficiency: countries could choose price despite the possibility of achieving higher social welfare from choosing quantity. The paper shows that the social welfare from non-cooperatively chosen quantities (e.g., emissions quotas) can dominate the social welfare from even first-best price levels (e.g., carbon taxes). Strikingly, if cost-shocks are global, then global carbon taxes are inefficient unless the marginal abatement cost function's slope exceeds the marginal benefit function's slope times 80,000. JEL Codes: C7, D8, F5, H21, Q28, Q58. Keywords: prices vs. quantities, policy instruments, global pollution