Prices vs. quantities: Public finance and the choice of regulatory instruments

Abstract

Since Montgomery [1972. Markets in licenses and efficient pollution control programs. Journal of Economic Theory 5, 395–418] and Weitzman [1974. Prices vs. quantities. Review of Economic Studies 41, 477–491], it has generally been assumed that, in a full-information setting, tradable quotas and taxes are equivalent regulatory instruments. We demonstrate that, if the government is movitated by public-finance concerns, this equivalence holds only if quotas are short lived. Moreover, the government prefers quotas with the shortest possible lifetime, or, what is equivalent in our setting, taxes.