Endogenous technical change and environmental regulation

Description/Abstract

A model of environmental regulation under uncertainty is developed to compare the effect of price versus quantity rules upon technical change. Starting with Weitzman's model of regulation under uncertainty, endogenous technical change is added. Quantity rules tend to encourage more efficient levels of technical change. Under price rules, firms tend to overreact, producing either too much or too little research and development depending upon the realization of the stochastic element of the model. This technical change advantage of quantity rules comes from the uncertainty surrounding the benefits of research and development. Uncertainty about the costs of research and development favors neither rule but simply increases the importance of choosing the correct rule.