Prices versus quantities in a vintage capital model

The heterogeneity of the available physical capital with respect to productivity and emission intensity is an important factor for policy design, especially in the presence of emission restrictions. In a vintage capital model, reducing pollution requires to change the capital structure through investment in cleaner machines and to scrap the more polluting ones. In such a setting we show that emission tax and auctioned emission permits may yield contrasting outcomes. We also show that some failures in the permits market may undermine its efficiency and that imposing the emission cap over longer periods plays a regularizing role in the market. 1 Université catholique de Louvain, CORE and Louvain School of Management, Chair Lhoist Berghmans in Environmental Economics and Management, B-1348 Louvain-la-Neuve, Belgium. Email: [email protected]. This author is also member of ECORE, the newly created association between CORE and ECARES. 2 Institute of Mathematics and Informatics, Bulgarian Academy of Sciences, 1113 Sofia, Bulgaria. Email: [email protected] 3 Institute of Mathematical Methods in Economics, Vienna Institute of Technology, A-1040 Vienna, Austria. E-mail: [email protected] This research was partly financed by the Austrian Science Foundation (FWF) under grant No P18161-N13 and by the Belgian Science Policy under the CLIMNEG project (SD/CP/05A). This paper presents research results of the Belgian Program on Interuniversity Poles of Attraction initiated by the Belgian State, Prime Minister's Office, Science Policy Programming. The scientific responsibility is assumed by the authors.