The Role of Stocks and Shocks Concepts in the Debate Over Price Versus Quantity

Many economists and policy makers have long favored the use of a price instrument to control greenhouse gases because they are a stock pollutant and as such the marginal benefit of abatement is relatively flat. While the early literature on the problem is consistent with this view, the later literature is less categorical. It showed that the choice between a price or quantity control depends, in part, upon the assumption on the dynamic structure of cost uncertainty. Temporary shocks to abatement cost favors the use of a price control, while permanent shocks favor a quantity control. Unfortunately, the importance of this assumption to the optimal choice has not yet received wide currency among economists. We analyze the problem in an alternative setting and reproduce the result that temporary shocks favor use of a price control while permanent shocks favor use of a quantity control. Our contribution is the simplicity of the model and the accessibility of the results, which reinforce the critical role played by the assumed structure of uncertainty.