- When there is uncertainty about future demand for the good’s output or the value of one of its attributes (e.g., vehicle footprint), at least some amount of output or attribute-basing improves expected welfare relative to a “flat” emissions standard. Substantial output-basing, or even an intensity standard (which regulates emissions proportionately to output), can improve economic efficiency when uncertainty about future demand is large relative to the damages caused by emissions.
- Uncertainty about fuel prices alone cannot justify output or attribute-based standards on economic efficiency grounds.
- For attribute-based fuel economy standards, uncertainty about future demand for vehicle size is so small that the optimal footprint-based standard is essentially flat. Thus, accounting for uncertainty does not substantially alter the conclusions of Ito and Sallee (2018) that footprint-based fuel economy standards are inefficient.
- Uncertainty about the future demand for electricity is large, so that an intensity standard—such as the rate-based standards envisioned by the Obama-era Clean Power Plan–can potentially out-perform a fixed emissions standard. Under a flat standard, uncertainty implies that the standard has a high risk of never binding (if demand is low or the price of low-carbon fuels is low) or of imposing a very high abatement cost (if demand is high or the price of low-carbon fuels is high).
- A tax on carbon yields strictly greater expected welfare than flat, output-based, or attribute-based standards, since the tax eliminates abatement cost uncertainty while avoiding distortions to output or to goods’ attributes. The same is true of an emissions cap that is indexed to exogenous sources of uncertainty (such as fuel prices or GDP) rather than to endogenously-determined objects such as goods’ output or attributes.
Areas of Focus: Energy Markets, Transportation, Climate Change, Fuel Economy Standards
Well-functioning markets are essential for providing access to reliable, affordable energy. EPIC research is uncovering the policies, prices and information needed to help energy markets work efficiently.
Mobility is central to economic activity. Yet, a lack of fuel diversity and continued demand growth have made the transportation industry a major contributor to global pollution and carbon emissions....
Climate change is an urgent global challenge. EPIC research is helping to assess its impacts, quantify its costs, and identify an efficient set of policies to reduce emissions and adapt...
Fuel Economy Standards
Fuel economy standards are the United States’ cornerstone transportation policy aimed at reducing both oil consumption and greenhouse gas emissions. EPIC research is exploring whether these standards are structured optimally...