NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Optimal Policy Instruments for Externality-Producing Durable Goods Under Time Inconsistency

Garth Heutel

NBER Working Paper No. 17083
Issued in May 2011
NBER Program(s):   EEE   PE

When consumers exhibit present bias and are time-inconsistent, the standard solution to market failures caused by externalities—Pigouvian pricing—is suboptimal. I investigate policies aimed at externalities for time-inconsistent consumers. Welfare-maximizing policy in this case includes an instrument to correct the externality and an instrument to correct the present bias. Either instrument can be an incentive-based policy or a command-and-control policy. Calibrated to the US automobile market, simulation results from a model with time-inconsistent consumers suggest that the second-best gasoline tax is 18%–30% higher than marginal external damages. These simulations also suggest that social welfare is maximized with a gasoline tax set about equal to marginal external damages and a fuel economy tax that increases the price of an average non-hybrid car by about $750–$2200 relative to the price of an average hybrid car.

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Document Object Identifier (DOI): 10.3386/w17083

Published: " How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shock s . " Review of Economic Dynamics , Vol. 15, No. 2 (April 2012), 244 - 264.

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