Prices versus Quantities versus Hybrids in the Presence of Co-pollutants
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We investigate the optimal regulation of a pollutant given its interaction with another controlled pollutant under asymmetric information about firms’ abatement costs. The co-pollutant is regulated, but perhaps not efficiently. Our focus is on optimal instrument choice in this setting, and we derive rules for determining whether a pollutant should be regulated with an emissions tax, tradable permits, or a hybrid price and quantity policy, given the regulation of its co-pollutant. The policy choices depend on the relative slopes of the damage functions for both pollutants and the aggregate marginal abatement cost function, including whether the pollutants are complements or substitutes in abatement and whether the co-pollutant is controlled with a tax or tradable permits.