The International Yearbook of Environmental and Resource Economics 2006/2007
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The International Yearbook of Environmental and Resource Economics 2006/2007

A Survey of Current Issues

Edited by Tom Tietenberg and Henk Folmer

This major annual publication presents a comprehensive overview of cutting-edge issues in environmental and resource economics.
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Chapter 4: Environmental Policy Under Imperfect Competition

Till Requate


* Till Requate 1. INTRODUCTION It is well known that due to their static efficiency economists prefer marketbased instruments of environmental policy such as emission taxes and tradable permits, to command and control. According to the Pigouvian rule, the optimal price of pollution should be equal to marginal social damage. Thus, since competitive firms equalize their marginal abatement costs to the price of pollution, notably an emission tax rate or a price for tradable permits, a socially optimal allocation can be decentralized. This is because (a) marginal abatement costs are levelled out among all the polluters, and (b) marginal abatement costs are equalized to marginal damage. At an early stage, Buchanan and Stubblebine (1962) and Buchanan (1969) challenged the Pigouvian paradigm by pointing out that a monopolist distorts the market allocation by holding down output. Therefore, a Pigouvian tax established to regulate emissions by a polluting monopolist would exacerbate the distortion. Starting from this observation, Buchanan (1969) launches a general attack against emission taxes in imperfectly competitive markets. He writes ‘This note is presented as a contribution to the continuing dismantling of the Pigouvian tradition in applied economics’ and ‘the whole approach of the Pigouvian tradition is responsible for many confusions in applied economics that are slowly to be clarified . . . making the marginal private cost as faced by the decision-taking unit equal to marginal social cost does not provide the Aladdin’s Lamp for the applied welfare theorist, and the sooner he recognizes this the better.’ Finally, on the relationship...

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