Relative standards: A positive and normative analysis

Abstract

The paper considers relative standards which limit the level of emissions per unit of output. The representative firm is characterized by a cost function describing the actual production process, a separate abatement technology, and the fact that (gross) emissions are proportional to output. At first, the implications of a relative standard and of its marginal change for a single firm are examined. It is shown that the standard cannot be replaced by a corresponding tax. Afterwards a positive analysis is performed for an industry consisting of identical firms under perfect competition. Comparative statics are used to analyze the impacts of changes in the relative standard in a short-run and long-run equilibrium. It turns out that the standard always possesses a price effect. Moreover the relevant factors which govern price, quantity, and profit changes are revealed. Then the paper characterizes the optimal standard for the same framework. A main result is that the first-best allocation can never be obtained by means of a relative standard, even if firms are identical. The influence of the demand and supply side on an optimal standard can be demonstrated since the underlying model is simple and transparent. The resulting market price is compared to social marginal costs. Finally the investigation is extended to monopoly and symmetric oligopoly.