Pricing externalities and moral behaviour

Abstract

To measure how moral behaviour interacts with pricing regimes, we conduct highly controlled experiments in which trading creates pollution. We compare indirect pricing (here, a cap and trade mechanism) and direct pricing (a tax) in an otherwise equivalent setting in which ‘producers’ are incentivized to emit CO2. ‘Judges’ decide on central trading parameters that may restrict socially harmful activities. Profit maximization predicts the same producer behaviour in either setting in the absence of regulation, yet we find a substantial share of producers refraining from emitting CO2 at all. Although judges restrict behaviour in similar ways across mechanisms, direct pricing more effectively accommodates moral behaviour than the quantity policy. Moral concerns matter for decisions in markets where activities generate negative externalities such as pollution emissions. With controlled experiments in which trading creates pollution, this study shows that a large portion of producers refrain from polluting even at the cost of forgoing profits.