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Price vs. quantity approaches

By Yesun Kim
web posted October 22, 2018

On October 8th, 2018, the Yale economist William D. Nordhaus was awarded the 2018 Nobel Memorial Prize in Economic Sciences for addressing governments to deal with climate change by imposing a tax on carbon emissions (Appelbaum, 2018). One of his essays, “To Tax or Not to Tax: Alternative Approaches to Slowing Global Warming” specifically discusses various ways to slow global warming regarding this issue. Dr. Nordhaus presents two kinds of approaches to slowing global warming: quantity-oriented mechanisms like the Kyoto Protocol and price-type control mechanisms, such as international harmonized carbon taxes (Nordhaus, 2007). Then, he argues that the Kyoto Protocol, a current international institution for slowing global warming, is inefficient as it is quantity-oriented. As he considers the balance between prices and quantities in price type approaches and quantitative approaches, he concludes that price type approaches are more efficient than quantity-oriented approaches.

First, Dr. Nordhaus believes that because of the complicated nature of the issue of global warming, price type approach is more favorable. Global warming is a type of global public goods, which are economic or other activities whose impacts are indivisible and whose influences are felt around the world rather than affecting one nation, town, or family (Nordhaus, 2007). Since global warming involves all the countries, it is more difficult to solve the issue efficiently and effectively. For example, one would have to decide the level of emission reductions, the distributions of emissions reductions across countries, the mechanism to encourage participation of low-income countries etc. (Nordhaus, 2007). Thus, considering that global warming is such a complex issue, Dr. Nordhaus argues that price type approaches are more effective than quantitative approaches. Price type approaches involve mechanisms such as harmonized carbon taxes (HCT), which are dynamically efficient Pigovian taxes that balance the discounted social marginal costs and marginal benefits of additional emissions (Nordhaus, 2007). This mechanism works more efficiently because it can easily integrate economic costs and benefits of emissions reductions, while the quantitative approach has no clear connection with ultimate environmental or economic goals (Nordhaus, 2007). Moreover, emissions taxes are more effective because quantitative limits can produce high volatility in the market price of carbon under an emissions-targeting approach (Nordhaus, 2007).

Of course, there are drawbacks of price type approaches. This is a relatively unexplored approach in international environmental agreements, and it might take too long for the international community to fiddle with tax rates, definitions, measurement issues and coverage (Nordhaus, 2007). Moreover, people generally distrust price approaches because these usually do not impose explicit limitations on the growth in emissions (Nordhaus, 2007). However, as Dr. Nordhaus considers the opportunity costs of the quantitative approach, which are its lack of flexibility and the potential to complicate an international market system, he concludes that the price type approach is more efficient. Yes, price type approaches could be complicated and not readily accepted by the international community, but the benefits of price type approaches outweigh their opportunity costs, compared to the opportunity costs of choosing quantitative approaches.

My personal example also proves that price type approaches can be more effective than quantitative approaches to produce a favorable outcome. When I was living with my friends in my host family’s house, we had to make a cleaning schedule with a weekly rotation because our house got messy. However, we often forgot to do our chores, and I had to enforce a rule that whenever we miss a chore, we would have to make up for it by doing it twice. This can be considered as a quantitative approach, and in this case, it was very ineffective. We ended up pushing off chores after chores that we had to do for missing a chore, and as there was no real consequence for missing chore, our house got very dirty. After much deliberation, I concluded that each time we miss a chore, we would have to pay a fine of one dollar, which can be seen as a price type approach. Surprisingly, this was very effective! Initially, we collected a lot of fines as we were used to forgetting to do a chore. However, over time, as we all dreaded to pay so much money just for missing a chore, we all began to remember and faithfully do our chores. Thus, in this case, a price type approach worked more efficiently than a quantitative approach because it had concrete implications of our actions. ESR

Yesun Kim is a high school student studying AP Macroeconomics. © 2018 Yesun Kim.

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