Uncertainty and Policy Choice: Carbon Tax or Emissions Trading Scheme

As we explained in Chaps. 1 and 3 , regulations, taxation, or any policy instruments could maximize social surplus if policymakers have perfect information about the demand curve, supply curve, and marginal external cost curve. In reality, however, governments do not have perfect information and therefore can mistakenly determine the optimal level of production, emissions, or an environmental tax, resulting in a decrease in social surplus. In this chapter, we consider which policy option is desirable—environmental taxes (we take a carbon tax as an example) or emissions trading schemes—to mitigate a decrease in social surplus in the presence of uncertainty due to imperfect information.