Cost Heterogeneity and the Potential Savings from Market-Based Policies

Abstract

Policy makers and analysts are often faced with situations where it is unclear whether market-based instruments hold real promise of reducing costs, relative to conventional uniform standards. We develop analytic expressions that can be employed with modest amounts of information to estimate the potential cost savings associated with market-based policies, with an application to the environmental policy realm. These simple formula can identify instruments that merit more detailed investigation. We illustrate the use of these results with an application to nitrogen oxides control by electric utilities in the United States.

Keywords: Environment, Policy Instruments, Market-based, Tradable Permits, Pollution Taxes, Uniform Standards

JEL Classification: Q28, Q38, K2, H4