Coase vs. Pigou in the Petroleum Market

Ju Vinn Chai, Cen Chen, Fabienne Giauque, Wei Zhu


Non-renewable resources such as fossil fuels are used extensively in industrial activities and transportation. The carbon emissions gene rated from those markets are the source of a number of negative externalities such as air pollution, climate change , global warming, and the degradation of ecosystems and natural environments. To alleviate such externalities societies are usually left with one of two choices. Governments may choose to impose carbon taxes on consumers and heavy-emitting industries. This is effectively a Pigovian tax regulation, which seeks to make market participants internalize the cost of externalities into their private costs in the hope that the net increase in the cost reduces the size of the externality. As an alternative, governments may use the price mechanism of markets rather than a direct tax. This could be called a Coasian approach to curbing the externality. It usually involves creating property rights over the resource that is being polluted (e.g. air or water) and trading rights to access it. A typical example might be the creation of pollution units such as emission permits or carbon allowances. Through the trading of permits among consumers, mark et forces determine the price of carbon which facilitates an efficient reduction of emissions. In this paper, we debate the relative merits and problems of both approaches - a Coasian market solution and a Pigovian tax regulation. We consider so me concrete applications of both theoretical concepts in doing so.

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