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Pricing Externalities

Pricing Externalities. Social cost of using DDT in 1962. expect better estimates in 1992. of the social cost of using DDT in 1962. ?. ongoing research about the harm of DDT. increasing use in. agriculture. 1992. 1939. 1962. 1972. Paul H. Müller discovers uses of

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Pricing Externalities

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  1. Pricing Externalities

  2. Social cost of using DDT in 1962 expect better estimates in 1992 of the social cost of using DDT in 1962 ? ongoing research about the harm of DDT increasing use in agriculture 1992 1939 1962 1972 Paul H. Müller discovers uses of DDT as insecticide Publication of Rachel Carson’s Silent Spring Most uses of DDT banned in the US Goal: Design a pricing mechanism for externalities that is responsive to future information about the cost of today’s externalities

  3. A Market in Emission Bonds (1) Emitters must buy a bond that matures in  periods time t (today) time t + Bond’s face value = expected upper limit of the social cost of the marginal unit of emissions Bond’s redemption value = time t + value of the difference between the bond’s face value and the time t+ estimate of the harm caused at time t, or zero (whichever is larger)

  4. A Market in Emission Bonds (2) Establish a market in which these bonds are traded (a) Bond’s price reflects  PV of expected time t + redemption values  provides estimate of harm (if below time t’s upper limit)  permits collection of plausible liabilities from emitters  uncertainty of redemption values/of harm of time t emissions  emitters bear the cost of the uncertainty that they cause (b) Market provides emitters with  liquidity  the opportunity to hedge risk regarding their liability for current, past and future emissions

  5. A Market in Emission Bonds (3) Comparison of mechanisms: (a) Traditional Pigouvian mechanisms: At time t, regulator  estimates harm  charges emitters social cost of harm (b) Our mechanism: At time t, regulator  estimates upper limit of harm  requires emitters to buy bonds At time t+, regulator  estimates social cost of time t harm  refunds overpayment to bond holders

  6. A Market in Emission Bonds (4) Public Choice aspects: (a) Regulator is motivated by efficiency considerations: • Has incentive to  assess harm as accurately as possible •  provide market participants with assessment •  market participants can use regulator’s assessment • as well as any additional information from research in • medicine, biology, climatology etc •  Market prediction of social cost will be at least as accurate • as regulator’s estimate

  7. A Market in Emission Bonds (4) Public Choice aspects: (b) Regulator is not motivated by efficiency considerations: (i) Time t assessments: •  regulator willfully underassesses social cost of emissions: •  bond’s price falls to zero, underassessment becomes visible •  regulator willfully overassesses social cost of emissions: •  bond’s price will be higher, emitters can escape • overly strict regulation (ii) Time t +assessments: •  affect liability for emissions that have occurred t years ago •  affect bondholders, not necessarily emitters

  8. Thank you! Nicolaus Tideman Virginia Tech ntideman@vt.edu Florenz Plassmann Binghamton University and National Science Foundation fplass@binghamton.edu

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