Martin L. Weitzman

Prices vs. Quantities

The setting for the problem under consideration is a large economic organization or system which in some cases is best thought of as the entire economy. Within this large economic organization resources are allocated by some combination of commands and prices (the exact mixture is inessential) or even by some other unspecified mechanism. The following question arises. For one particular isolated economic variable that needs to be regulated,3 what is the best way to implement control for the benefit of the organization as a whole? Is it better to directly administer the activity under scrutiny or to fix transfer prices and rely on self-interested profit or utility maximization to achieve the same ends in decentralized fashion? This issue is taken as the prototype problem of central control which is studied in the present paper. There are a great many specific examples which fit nicely into such a framework. One of current interest is the question of whether it would be better to control certain forms of pollution by setting emission standards or by charging the appropriate pollution taxes. When quantities are employed as planning instruments, the basic operating rules from the centre take the form of quotas, targets, or commands to produce a certain level of output. With prices as instruments, the rules specify either explicitly or implicitly that profits are to be maximized at the given parametric prices. Now a basic theme of resource allocation theory emphasizes the close connection between these two modes of control. No matter how one type of planning instrument is fixed, there is always a corresponding way to set the other which achieves the same result when implemented.4 From a strictly theoretical point of view there is really nothing to recommend one mode of control over the other. This notwithstanding, I think it is a fair generalization to say that the average economist in the Western marginalist tradition has at least a vague preference toward indirect control by prices, just as the typical non-economist leans toward the direct regulation of quantities. That a person not versed in economics should think primarily in terms of direct controls is probably due to the fact that he does not comprehend the full subtlety and strength of the invisible hand argument. The economists attitude is somewhat more puzzling. Understanding that prices can be used as a powerful and flexible instrument for rationally allocating resources and that in fact a market economy automatically regulates itself in this manner is very different from being under the impression that such indirect controls are generally preferable for the kind of problem considered in this paper. Certainly a careful reading of economic theory yields little to support such a universal proposition.

ON MODELING AND INTERPRETING THE ECONOMICS OF CATASTROPHIC CLIMATE CHANGE

With climate change as prototype example, this paper analyzes the implications of structural uncertainty for the economics of low-probability, high-impact catastrophes. Even when updated by Bayesian learning, uncertain structural parameters induce a critical tail fattening of posterior-predictive distributions. Such fattened tails have strong implications for situations, like climate change, where a catastrophe is theoretically possible because prior knowledge cannot place sufficiently narrow bounds on overall damages. This paper shows that the economic consequences of fat-tailed structural uncertainty (along with unsureness about high-temperature damages) can readily outweigh the effects of discounting in climate-change policy analysis.

On the Welfare Significance of National Product in a Dynamic Economy

I. Introduction, 156. — II. A formulation of the problem, 156. — III. What is net national product? 159. — IV. Proof of the main proposition, 160. — V. Unanticipated technological change: an application, 161.

Optimal Search for the Best Alternative

This paper completely characterizes the solution to the problem of searching for the best outcome from alternative sources with different properties. The optimal strategy is an elementary reservation price rule, where the reservation prices are easy to calculate and have an intuitive economic interpretation.

FUNDING CRITERIA FOR RESEARCH, DEVELOPMENT, AND EXPLORATION PROJECTS

Department of Energy, nor any of their employees, nor any of their contractors, subcontractors, or their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of any information, apparatus, product or process disclosed or represents that its use would not infringe privately owned rights. ABSTRACT The sequential nature of activities like research, development, or exploration requires optimal funding criteria to take account of the fact that subsequent funding decisions will be made throughout the future. Thus, there is a continual possibility of reviewing a projects status, based on the latest information. After setting up a model to capture this feature, optimal funding criteria are investigated. In an important special case, an explicit formula is derived. As well as throwing light upon the nature of development activities, the analysis is also relevant to the general theory of information gathering processes. for energy research and development and more specifically for management decisions in the Photovoltaic Program.

Fat-Tailed Uncertainty in the Economics of Catastrophic Climate Change

In this article, I revisit some basic issues concerning structural uncertainty and catastrophic climate change. My target audience here are general economists, so this article could also be viewed as a somewhat less technical exposition that supplements my previous work. Using empirical examples, I argue that it is implausible that low-probability, high-negative impact events would not much influence an economic analysis of climate change. I then try to integrate the empirical examples and the theory together into a unified package with a unified message that the possibility of catastrophic climate change needs to be taken seriously.

Determining Benefits and Costs for Future Generations

The United States and others should consider adopting a different approach to estimating costs and benefits in light of uncertainty. In economic project analysis, the rate at which future benefits and costs are discounted relative to current values often determines whether a project passes the benefit-cost test. This is especially true of projects with long time horizons, such as those to reduce greenhouse gas (GHG) emissions. Whether the benefits of climate policies, which can last for centuries, outweigh the costs, many of which are borne today, is especially sensitive to the rate at which future benefits are discounted. This is also true of other policies, e.g., affecting nuclear waste disposal or the construction of long-lived infrastructure.

Does NNP growth indicate welfare improvement

We show that instantaneous increases in real NNP over time are an accurate indicator of true dynamic welfare improvements. This highlights a connection between the theory of green (or comprehensive) national income accounting and the theory of real price indices.  2001 Elsevier Science B.V. All rights reserved.

OPEC and the monopoly price of world oil

The report presents a dynamic model of the behavior of OPEC viewed as a monopolist sharing the world oil market with a competitive sector. In order to study the influence of long-term considerations on the price of oil, a dynamic model of the capital theoretic type was built.

Asymmetries in price and quantity adjustments by the competitive firm

Focusing on the crucial role of inventory carry-overs in the production and sales decision, we describe the profit maximizing behavior of a dynamic competitive firm facing random prices. Each firm’s behavior is incorporated into a stochastic equilibrium model of the competitive industry with uncertain demand. The industry model exhibits asymmetric cyclical fluctuations of the “Keynesian” sort: when demand is weak, output contracts while price holds at a fixed floor; when demand is strong, price increases as output is constrained by a ceiling. Even in a pure world of constant returns, without increasing costs, the inability to instantaneously coordinate production and sales along with the existence of inventories is sufficient to yield a “backward I,” shaped supply curve for the short run. Journal of Economic Literature Classification Numbers: 020, 021. 022.