Prices vs. Quantities with Multiple Countries

Abstract

What is the best way to price carbon and enhance other global public goods? To answer the question, this paper examines a policy-making game among many countries in the face of cost uncertainty. Governments choose both the type of policy: price or quantity (e.g., carbon tax or emissions quota) and the intensity of a policy (i.e., price level or quantity level). The analyses indicate that countries tend to choose the price instrument despite the quantity instrument being superior from a welfare perspective. If cost shocks are country-specific, global carbon taxes are inefficient unless the ratio of the slope of the marginal abatement cost function to the slope of the marginal benefit function exceeds the number of sovereign countries (i.e., 200). If cost shocks are world-wide, global carbon taxes are inefficient unless the ratio of the slope of the marginal abatement cost function to the slope of the marginal benefit function exceeds 80; 000 (i.e., 22002). Strikingly, the results suggest that the social welfare from non-cooperatively chosen quantities (e.g., emissions quotas) may dwarf the social welfare from first-best price levels (e.g., carbon taxes).