uncertainty and endogenous technical change in climate policy models until recently endogenous technical change and uncertainty have been modeled separately in climate policy models in this paper we review the emerging literature that considers both these elements together taken as a whole the literature indicates that explicitly including uncertainty has important quantitative and qualitative impacts on optimal climate change technology policy

flexibility and uncertainty the preserving of flexibility when faced with uncertainty is a neglected aspect of behaviour under risk yet it is an important factor in decisions to hold liquid assets or delay irreversible investment this paper formalizes the notion of flexibility in a sequential decision context and relates its value to the amount of information an agent expects to receive a rudimentary money demand model is developed embodying these ideas and the history of flexibility as an economic concept is traced choices are frequently made between alternatives that imply different degrees of future commitment between a short term investment that leaves future options open for example and a long term one that by its very nature forecloses those options the relative attractiveness of the two depends on their probability distributions of payoffs over time a basic consideration in this choice is the recognition that beliefs about the risks governing these payoffs may change current doubts may be partially resolved in the near future this prospect decreases the attractiveness of the longer term commitment in that one is able to respond less fully to new information and even if it does not directly affect the risks associated with shorter term choices enhances their appeal this paper formalizes the above remarks by establishing connections between the following two partial orderings the first is an ordering based on variability of beliefs one set of beliefs is more variable than another if more final risk is resolved at an intermediate stage the more one expects to learn by an intermediate period relative to what one knows today the more variation one is anticipating in beliefs about the final outcome the second is an ordering of current actions or positions based on flexibility one position is more flexible than another if it leaves available a larger set of future positions at any given level of cost these two orderings are incorporated in a simple sequential decision model to suggest the following behavioural principle the more variable are a decision maker s beliefs the more flexible is the position he will choose this principle potentially applies whenever i there will be opportunities to act after further information is received and ii current actions influence either the attractiveness or availability of different future actions

the kyoto protocol a review and perspectives international concern about climate change has led to the kyoto protocol negotiated in 1997 which contains legally binding emission targets for industrialized countries to be achieved during the commitment period 2008 2012 while proponents of the protocol celebrate it as a breakthrough in international climate policy opponents criticize that its approach namely setting targets and timetables for emission reductions is seriously flawed this paper provides a critical assessment of the protocols potential performance and discusses amendments to foster its effectiveness and efficiency it concludes that even without any effective emission reductions in the initial commitment period the ratification of kyoto is important for the further policy process of climate protection the kyoto protocol has established a flexible broad based international mechanism that provides a valuable starting point for shaping efficient climate policies in the future

the irreversibility effect in environmental decisionmaking we provide a new more general definition for the irreversibility effect and demonstrate its relevance to problems involving environmental and other decisions under uncertainty we establish several analytical and numerical results that suggest both that the effect holds more widely than generally recognized and that an existing result epstein s theorem giving a sufficient condition for determining whether the effect holds can be applied more widely than previously indicated in particular to problems involving intertemporally nonseparable benefit functions we further show that a low elasticity of intertemporal substitution will however result in failure of the effect

non convexities and the efficiency of equilibria in insurance markets with asymmetric information abstract the nature of the efficiency frontier in models with adverse selection has not been studied in the literature we show that this frontier cannot always be strictly concave we obtain however that there is always a one to one correspondence between market equilibrium and second best efficiency whatever the shape of the efficiency frontier the results are illustrated with an insurance example

global warming irreversibility and learning a number of economists have argued that the literature on the irreversibility effect implies that current abatement of greenhouse gas emissions should be greater when there is the possibility of obtaining better information in the future about the potential damages from global warming than when there is no possibility of obtaining better information in this paper we show that even the simplest model of global warming does not satisfy either of epstein s 1980 sufficient conditions so it is not possible to use epstein s analysis to tell whether the irreversibility effect applies to models of global warming we derive an alternative sufficient condition for the irreversibility effect to hold

endogenous quality differentiation in congested markets firms selling a product with congestion externalities to a heterogeneous population of customers have an incentive to offer differentiated levels of quality in a price competitive market differentiation arises endogenously through the prices chosen by firms in equilibrium firms offer a range of prices which induce an efficiency improving range of quality levels and allow customers to self select their preferred price quality combinations additional results suggest that with many firms in the market the choice of prices dominates the choice of service capacities in determining congestion levels copyright 1991 by blackwell publishing ltd

optimal learning on climate change why climate skeptics should reduce emissions climate skeptics typically argue that the possibility that global warming is exogenous implies that we should not take additional action towards reducing emissions until we know what drives warming this paper however shows that even climate skeptics have an incentive to reduce emissions such a directional change generates information on the causes of global warming since the optimal policy depends upon these causes they are valuable to know although increasing emissions would also generate information that option is inferior due its irreversibility we show that optimality can even imply that climate skeptics should actually argue for lower emissions than believers

precautionary principle and the optimal timing of environmental policy under ambiguity i consider a problem in environmental policy design in which i focus on stock pollutants in particular i consider stock pollutants that cause severe damage on the environment and do not depreciate at all once they are released into the atmosphere and the ocean the purposes of this paper are 1 to provide an economic foundation for environmental policies based on the precautionary principle and the 1992 rio declaration on environment and development and 2 to show that this optimal timing rule has a reservation property furthermore i analyze the effect of an increase in ambiguity on the optimal timing of adopting some environmental policy and show that an increase in ambiguity decreases the optimal timing of adopting the environmental policy

optimal pricing of a congestible good with random participation abstract this paper studies the optimal pricing of a congestible network good offered by a monopoly who faces a double asymmetry of information concerning both users valuations and users unit waiting costs which leads to a random participation problem we show that the textbook price is lower than the price with random participation

tariffs with private information and reputation abstract several tariff games are examined in which the home country has private information about whether its government is a low or high tariff type if the foreign government is uncertain about this type in a one shot game its nash equilibrium tariff will be lower higher than if it knew the home government were a low high tariff type in two multistage games misleading behavior by the home government is an equilibrium strategy for sufficiently high discount factors whether or not uncertainty is persistent is important for welfare results tariff rules do not necessarily dominate discretionary policy in these models

precautionary principle and robustness for a stock pollutant with multiplicative risk the interest shown by policy makers and economists in the precautionary principle indicates the importance of model uncertainty in global warming policy i show that through robust control policy makers can implement the precautionary principle to regulate a stock pollutant and i analyze its effect on expected steady state pollution taxes stocks and welfare the paper is broadly comprised of a theoretical part and an application to global warming policy i find that 1 an increase in either uncertainty about the model or risk about abatement cost increases expected steady state pollution taxes 2 a robust policy is preferred for any level of model uncertainty and this preference increases for either higher model uncertainty or higher multiplicative risk and 3 the effect on expected steady state pollution taxes and stock of introducing model uncertainty is relatively small for high levels of model uncertainty these results advocate using robust policies for a stock pollutant in the presence of model uncertainty

incentive compatible trade policies a two country trade model with production uncertainty is considered if complete contingent markets do not exist it is desirable for governments to adopt some trade policies to share the production risk a full information policy involves incomes transfers across countries which can be achieved by equal import tariffs and export subsidies with incomplete information we consider incentive compatible trade policies which are designed to be truth revealing while partially sharing the production risk in this case the tariff in one country may differ from the export subsidy abroad

looking for a guide to protect the environment the development of the precautionary principle abstract if the precautionary principle is to become the guide of the international community for environmental protection policies an economic interpretation of the principle is in order the analysis of case studies and a survey of the recent decision theoretic literature show the lack of a fully satisfactory economic model more generally various theoretical and empirical results show that the principle cannot be assumed to apply a priori though it has been proposed by international treaties as a rule of thumb for situations of scientific uncertainty the precautionary principle could actually be inefficient

fundamental irreversibilities in stock externalities abstract this paper concerns the irreversibility effect in stock externalities in an environment of uncertainty with learning taking place one may wish to under emit today to avoid potential environmental irreversibilities alternatively one may wish to under invest in pollution control capital avoiding investments in sunk capital that turn out to be wasted the paper develops theoretical results on the tension between these two effects and separates risk aversion from the irreversibility effect the paper also presents a simple example in climate change policy

using fast and slow processes to manage resources with thresholds economists have relied on convexity assumptions for a long time but many natural resources that stem from ecosystems have non convexities in their dynamics this article illustrates the consequences of relaxing convexity assumptions for management and the role of fast and slow variables the paper presents a general framework to handle systems with fast and slow variables and illustrates the method using a model of coral reefs subject to fishing pressure the insights obtained are used to discuss alternative management strategies

regulatory actions under adjustment costs and the resolution of scientific uncertainty food system regulators often decide whether to ban existing practices or approve new technologies without conclusive scientific evidence on possible damage and knowing that resolution is likely in the future in a model with three decision points and stochastic resolution of uncertainty we study interactions between expected losses due to regulation and information availability when a regulator is deciding on an early reversible ban and on a later reversible ban adjustment costs create inertia concerning intermediate signals such that earlier decisions are not overturned and also a bias against imposing an early ban the prospect of more later stage information can increase or decrease the incentive to ban early but research decreases the incentive to ban early

collusion and price rigidity we consider an in nitely repeated bertrand game in which prices are publicly observed and each rm receives a privately observed i i d cost shock in each period we focus on symmetric perfect public equilibria sppe wherein any punishments are borne equally by all rms we identify a tradeoff that is associated with collusive pricing schemes in which the price to be charged by each rm is strictly increasing in its cost level such fully sorting schemes offer efficiency bene ts as they ensure that the lowest cost rm makes the current sale but they also imply an informational cost distorted pricing and or equilibrium path price wars since a higher cost rm must be deterred from mimicking a lower cost rm by charging a lower price a rigid pricing scheme where a rm s collusive price is independent of its current cost position sacri ces efficiency bene ts but also diminishes the informational cost for a wide range of settings the optimal symmetric collusive scheme requires i the absence of equilibrium path price wars and ii a rigid price if rms are sufficiently impatient however the rigid pricing scheme cannot be enforced and the collusive price of lower cost rms may be distorted downward in order to diminish the incentive to cheat when the model is modi ed to include i i d public demand shocks the downward pricing distortion that accompanies a rm s lower cost realization may occur only when current demand is high

efficient dynamic pollution taxation in an uncertain environment this paper analyzes efficient pollution taxation within a stochastic model of endogenous growth pollution is a by product of production and causes disutility furthermore the productivity which results from environmental quality is uncertain this reflects e g uncertain capital depreciation induced by natural disasters like hurricanes or floods this uncertainty is shown to raise an ambiguous impact on the optimal pollution level as well as on optimal environmental taxation market equilibrium turns out to be suboptimal since the households mis perceive their individual impact on pollution conditions for welfare maximizing pollution taxation are stated and it is shown that a direct pollution tax is not appropriate to yield pareto optimal growth instead a linear capital income tax together with a linear abatement subsidy build an efficient tax scheme if secondarily the governmental budget is balanced moreover an increase in the riskiness of environmental productivity may even lead to an increase in the optimal pollution level and to a decrease in optimal environmental taxation depending predominantly on the preference parameters

optimal climate policy is a utopia from quantitative to qualitative cost benefit analysis abstract the dominance of quantitative cost benefit analysis cba and optimality concepts in the economic analysis of climate policy is criticised among others it is argued to be based in a misplaced interpretation of policy for a complex climate economy system as being analogous to individual inter temporal welfare optimisation the transfer of quantitative cba and optimality concepts reflects an overly ambitious approach that does more harm than good an alternative approach is to focus the attention on extreme events structural change and complexity it is argued that a qualitative rather than a quantitative cba that takes account of these aspects can support the adoption of a minimax regret approach or precautionary principle in climate policy this means implement stringent ghg reduction policies as soon as possible

environmental prices uncertainty and learning there is an increasing demand for putting a shadow price on the environment to guide public policy and incentivize private behaviour in practice setting that price can be extremely difficult as uncertainties abound there is often uncertainty not just about individual parameters but about the structure of the problem and how to model it a further complication is the second best nature of real environmental policy making in this paper we propose some practical steps for setting prices in the face of these difficulties drawing on the example of climate change we consider how to determine the overall target for environmental protection how to set shadow prices to deliver that target and how we can learn from the performance of policies to revise targets and prices perhaps most significantly we suggest that estimates of the marginal cost of environmental protection rather than the marginal benefit will often provide the more consistent and robust prices for achieving targets

on the role of retaliation in trade agreements this paper analyzes the role of retaliation in trade agreements it shows that in the presence of private information retaliation can always be used to increase the welfare derived from such agreements by the participating governments in particular it is shown that retaliation is a necessary feature of any efficient equilibrium we argue that retaliation would not be necessary if governments could resort to international transfers or export subsidies to compensate for terms of trade externalities within the current world trading system though in which transfers are seldom observed whereas export subsidies are prohibited the use of the remaining trade instruments in a retaliatory fashion might be optimal the model is used to interpret the retaliatory use of antidumping observed in the last decades and the proliferation of these measures relative to other trade remedies

a theory of managed trade this paper proposes a theory that predicts low levels of protection during periods of normal trade volume coupled with episodes of special protection when trade volumes surge this dynamic pattern of protection emerges from a model in which countries choose levels of protection in a repeated game facing volatile trade swings high trade volume leads to a greater incentive to defect unilaterally from cooperative tariff levels therefore as the volume of trade expands the level of protection must rise in a cooperative equilibrium to mitigate the rising trade volume and hold the incentive to defect in check copyright 1990 by american economic association

climate change mitigation and adaptation with uncertainty and learning one of the major issues in climate change policy is how to deal with the considerable uncertainty that surrounds many of the elements some of these uncertainties will be resolved through the process of further research this process of learning raises a crucial timing question should society delay taking action in anticipation of obtaining better information or should it accelerate action because we might learn that climate change is much more serious than expected much of the analysis to date has focussed on the case where the actions available to society are just the mitigation of emissions and where there is little or no role for learning we extend the analysis to allow for both mitigation and adaptation we show that including adaptation weakens the effect of the irreversibility constraint and so for this model makes it more likely that the prospect of future learning should lead to less action now to deal with climate change we review the empirical literature on climate change policy with uncertainty learning and irreversibility and show that to date the effects on current policy are rather small though this may reflect the particular choice of models employed

regulation with anticipated learning about environmental damages a regulator anticipates learning about the relation between environmental stocks and economic damages for a model with linear quadratic abatement costs and environmental damages and a general learning process we show analytically that anticipated learning decreases the optimal level of abatement at a given information set if learning causes the regulator to eventually decide that damages are higher than previously thought learning eventually increases abatement learning also favors the use of taxes rather than quotas using a model that is calibrated to describe the problem of global warming we show numerically that anticipated learning causes a significant reduction in first period abatement and a small increase in the preference for taxes rather than quotas even if the regulator s initial priors about environmental damages are much too optimistic he is able to learn quickly enough to keep the expected stock trajectory near the optimal trajectory

uncertain climate change in an intergenerational planning model a three generation planning model incorporating uncertain climate change is developed each generation features a production activity based on capital and an exhaustible resource an irreversible climate change may occur in period two or three reducing the productivity for this and the remaining generation the model is solved by stochastic dynamic programming if the climate impact and climate change probability is constant the optimal period one and two resource extraction is larger than for the reference case of climate stability if however climate impact and climate change probability increases with increased aggregate resource use this result is reversed

does hidden information make trade liberalization more fragile this paper focuses on the impact of hidden information on strategic interaction in the context of trade agreements in the presence of informational asymmetry it is possible that a tradeoff between liberalization and sustainability of cooperation emerges it is shown that it may be optimal to agree on a degree of liberalization associated with a strictly positive ex ante probability of deviation occurring in that case cooperation will break down in finite time and the optimal degree of liberalization cannot be applied indefinitely ce memoire etudie l impact de l information cachee sur l interaction strategique dans le contexte des accords de commerce quand il y a asymetrie de l information il est possible qu emerge une relation d equivalence entre la liberalisation et la viabilite de la cooperation on montre qu il peut etre optimal de s entendre sur un degre de liberalisation associea une probabilite ex ante strictement positive qu une deviation va se produire dans ce cas la cooperation va s effriter dans une periode finie et le degre optimal de liberalisation ne tient pas indefiniment

uncertainty and amenity values in renewable resource economics in this paper we study the effects of amenities and uncertainty on the optimal exploitation of a renewable resource first if society displays a protection motive in the presence of amenities its optimal harvesting strategy will be more conservative second we show that ecological uncertainty leads society to develop the opposite behavior thus reducing its exposition towards risk a stationary analysis is undertaken to analytically quantify and compare these two effects with a gompertz natural regeneration function and a proportional risk the amenity effect is proved to prevail if and only if stochastic fluctuations on the resource stock are not too large

politically realistic objective functions and trade policy profs and tariffs abstract this paper demonstrates a mathematical correspondence between the deus ex machina tariff formation approach and political economy approach the correspondence implies that the tariff chosen by lobbying influenced policy makers will be equivalent to a tariff chosen by a deus ex machina government that gives too much weight to profits this result allows many political economy issues to be addressed in the simple framework of a deus ex machina government which faces a politically realistic objective function prof

monopoly with incomplete information recent theoretical research on principal agent relationships has emphasized incentive problems that arise when the parties involved are constrained by either asymmetric information or their inability to monitor each other s actions here we concentrate on the former constraint and consider the case of a single principal the monopolist the main contribution is to show that under a separability assumption strong conclusions can be drawn about the nature of optimal incentive schemes although the primary focus is on optimal quantity discounts in a monopolized market the results also shed light on related topics such as optimal income taxation and commodity bundling

risk averse mitigation decisions in an unpredictable climate system risk aversion plays a central role in the decisions made in the face of uncertainties and climate change mitigation should be no exception however the interlinkage of risk aversion and climate change uncertainties has hardly been investigated numerically in part because of the computational difficulties of stochastic optimization in this paper we apply the numerical techniques of stochastic optimization to the economic modeling of climate change with the aim of modeling the decision preferences of a risk conscious agent in the face of unpredictable climate change the model underlines the critical role played by the risk aversion parameter in determining the effects of uncertainties on mitigation not only in level but also in sign

optimal pricing for selling a congestible good with countervailing incentives abstract we analyze optimal pricing when a monopolistic firm sells a good on a congestible network with countervailing incentives we show that the network capacity level is crucial to determine the optimal tariff

the folk theorem with imperfect public information the authors study repeated games in which players observe a public outcome that imperfectly signals the actions played they provide conditions guaranteeing that any feasible individually rational payoff vector of the stage game can arise as a perfect equilibrium of the repeated game with sufficiently little discounting the central condition requires that there exist action profiles with the property that for any two players no two deviations one by either player give rise to the same probability distribution over public outcomes the results apply to principal agent partnership oligopoly and mechanism design models and to one shot games with transferable utilities copyright 1994 by the econometric society

gatt a cooperative equilibrium in a noncooperative trading regime abstract as global tariff rates have fallen the use of nontariff barriers to trade have become more prevalent one incentive for a country to depart from free trade is to levy the optimal tariff in order to maximize domestic welfare the gatt was designed to maintain free trade through a system of managed retaliation as is well known in a game theoretic trade model of tariffs with no uncertainty free trade is an equilibrium outcome however with the introduction of uncertainty and asymmetric information it is shown that the equilibrium outcome s has each country imposing nontariff barriers to trade

nonlinear pricing with random participation the canonical selection contracting programme takes the agent s participation decision as deterministic and finds the optimal contract typically satisfying this constraint for the worst type upon weakening this assumption of known reservation values by introducing independent randomness into the agents outside options we find that some of the received wisdom from mechanism design and nonlinear pricing is not robust and the richer model which allows for stochastic participation affords a more general empirical specification we develop a multidimensional methodology for addressing this class of problems providing two important applications to nonlinear pricing first with nonlinear pricing by a monopolist the familiar nodistortion at the top result persists but in tandem with the surprising conclusion that there is either no distortion at the bottom or bunching second in a simple model of product differentiated duopolists competing with nonlinear pricing we show that generally the duopoly outcome is qualitatively similar to the monopoly outcome however when marginal costs are symmetric and competition is sufficiently intense distortions disappear and the equilibrium outcome takes a remarkably simple form efficient quality allocations with cost plus fee pricing

uncertainty learning and heterogeneity in international environmental agreements this paper concerns the formation of international environmental agreements under uncertainty about environmental damage with different models of learning complete learning partial learning or no learning the results of the existing literature are generally pessimistic the possibility of either complete or partial learning generally reduces the level of global welfare that can be achieved from forming an iea relative to no learning that literature regards uncertainty as a parameter common to all countries so that countries are identical ex ante as well as ex post in this paper we extend the literature to the case where there is no correlation between damage costs across countries each country is uncertain about a particular parameter in our case the benefit cost ratio drawn from a common distribution but ex post each country s realized parameter value is independently drawn consequently while countries remain identical ex ante they may be heterogeneous ex post we show that this change reinforces the negative conclusions about the effects of partial learning on international environmental agreements but under certain conditions moderates the negative conclusions about the effects of complete learning

optimal diversity increasing returns versus recombinant innovation abstract choices regarding diversity play an important role in economics and innovation management but often remain implicit once made explicit the objectives of efficiency and diversity are usually posed as in conflict as efficiency relates positively and diversity negatively to various increasing returns to scale in markets such a perspective however neglects the benefits of diversity in terms of realizing system improvements through recombinant innovation or spillovers the latter implies a contribution of diversity to long term efficiency dominant economic approaches that address diversity such as option value and real options theories regard benefits of diversity as exogenous this paper proposes a simple model of variable endogenous diversity to analyse the optimal balance between increasing returns to scale and recombinant innovation it is discussed under which conditions one of four solutions is optimal complete specialization regardless of which option complete specialization in one specific option symmetric diversity perfect balance and asymmetric diversity the results give rise to a number of policy insights

quantile maximization in decision theory this paper introduces a model of preferences in which given beliefs about uncertain outcomes an individual evaluates an action by a quantile of the induced distribution the choice rule of quantile maximization unifies maxmin and maxmax as maximizing the lowest and the highest quantiles of beliefs distributions respectively and offers a family of less extreme preferences taking preferences over acts as a primitive we axiomatize quantile maximization in a savage setting our axiomatization also provides a novel derivation of subjective beliefs which demonstrates that neither the monotonicity nor the continuity conditions assumed in the literature are essential for probabilistic sophistication we characterize preferences of quantile maximizers towards downside risk we discuss how the distinct properties of the model robustness and ordinality can be useful in studying choice behaviour for categorical variables and in economic policy design we also offer applications to poll design and insurance problems

precautionary principle as a rule of choice with optimism on windfall gains and pessimism on catastrophic losses abstract the paper investigates a decision making process involving both risk and ambiguity differently from existing papers basili m chateauneuf a fontini f 2005 choices under ambiguity with familiar and unfamiliar outcomes theory and decision 58 195 207 chichilnisky g 2000 axiomatic approach to choice under uncertainty with catastrophic risks resources and energy economics 22 221 231 chichilnisky g 2002 in el shaarawi a h piegorsch w w eds catastropic risks encyclopedia of environmetrics vol 1 john wiley sons ltd chichester uk pp 274 279 we assume that in a choquet expected utility framework the decision maker is pessimistic with respect to unfamiliar catastrophic losses optimistic with respect to unfamiliar windfall gains and ambiguity neutral with respect to the familiar world a representation of the decision maker s choice is obtained that mimics the restricted bayes hurwicz criterion in this way a characterization of the precautionary principle is introduced for decision making processes under ambiguity with catastrophic losses and or windfall gains

investment in risky r d programs in the face of climate uncertainty we analyze how the socially optimal technology rd and that uncertainty in damages interacts with uncertainty in the returns to rd and r d that reduces the emissions to output ratio and argue that this is a good representation of r d into fossil fuel technologies for r d programs into non carbon technologies optimal investment is higher in riskier programs our empirical model indicates that the optimal investment in a risky program is about 3 1 2 times larger than in a program with certain returns for r d programs aimed at reducing emissions in fossil fuel based technologies our results show that qualitatively investment is higher in less risky programs under most uncertain damage scenarios our empirical model shows however that the risk profile of fossil fuel based r d programs generally has little quantitative impact on optimal investment the exception is that when the probability of a catastrophe inducing full abatement is very high investment is about twice as high in risky programs compared to programs with certain returns

optimal management with potential regime shifts we analyze how the threat of a potential future regime shift affects optimal management we use a simple general growth model to analyze four cases that involve combinations of stock collapse versus changes in system dynamics and exogenous versus endogenous probabilities of regime shift prior work in economics has focused on stock collapse with endogenous probabilities and reaches ambiguous conclusions on whether the potential for regime shift will increase or decrease intensity of resource use and level of resource stock we show that all other cases yield unambiguous results in particular with endogenous probability of regime shift that affects system dynamics the potential for regime shift causes optimal management to become precautionary in the sense of maintaining higher resource stock levels

tacit collusion under interest rate fluctuations previous literature has shown that demand fluctuations affect the scope for tacit collusion i study whether discount factor fluctuations can have similar effects i find that collusion depends not only on the level of the discount factor but also and more surprisingly on its volatility collusive prices and profits increase with a higher discount factor level but decrease with its volatility these results have important implications for empirical studies of collusive pricing the role that collusive pricing may play in economic cycles and the study of cooperation in repeated games

dynamic tariffs with asymmetric information recent developments in dynamic game theory are applied to determine when two countries can sustain freer trade given that they determine trade policies non cooperatively countries know their own level of protection but not the other country s level of protection using import trigger strategies cooperation in the form of low tariffs can be supported although there are periodic reversionary high tariff episodes however if terms of trade trigger strategies are used cooperation does not occur

should we beware of the precautionary principle precautionary principle the economic perspective how should society deal with risks when there is scientific uncertainty about the size of these risks there has been much recent discussion of the precautionary principle which states that lack of full scientific knowledge should not be used as a reason to postpone cost effective preventive measures we show in this paper that the precautionary principle contradicts one important intuition about the right way to act in the face of risk namely the principle of looking before you leap when we expect to learn more about the future the effectiveness of our preventive measures will be greater if we learn before we act however a number of other ways of taking uncertainty into account are consistent with a reasonable interpretation of the precautionary principle first postponing preventive measures may increase our vulnerability to damage which induces a precautionary motive for risk prevention similar to the precautionary savings motive secondly stronger preventive actions often yield more flexibility for the future so that acting early has an option value thirdly when better information comes from a process of learning by doing the risk associated with early events is amplified by the information they yield about the future this plays a role analogous to that of an increase in risk aversion making us more cautious fourthly because imperfect knowledge of the risk makes it difficult to insure the social cost of risk should include a risk premium finally uncertainty about the economic environment enjoyed by future generations should be taken into account this raises the benefit of acting early to prevent long term risks if the precautionary principle sometimes gives good and sometimes gives bad advice there is no escape from the need to undertake a careful cost benefit analysis we show that standard cost benefit analysis can be refined to take account of scientific uncertainty in ways that balance the precautionary principle against the benefits of waiting to learn before we act furthermore it is important that they be used to do so for instinct is an unreliable guide in such circumstances abandoning cost benefit analysis in favour of simple maxims can result in some seriously misleading conclusions christian gollier

psychological expected utility theory and anticipatory feelings we extend expected utility theory to situations in which agents experience feelings of anticipation prior to the resolution of uncertainty we show how these anticipatory feelings may result in time inconsistency we provide an example from portfolio theory to illustrate the potential impact of anticipation on asset prices

optimal cartel equilibria with imperfect monitoring abstract there exist optimal symmetric equilibria in the green porter model 4 8 having an elementary intertemporal structure such an equilibrium is described entirely by two subsets of price space and two quantities the only production levels used by firms in any contingency the central technique employed in the analysis is the reduction of the repeated game to a family of static games

accounting for heterogeneous private risks in the provision of collective goods controversial compulsory contracting institutions in horizontal hydrofracturing abstract common pool resources are frequently analyzed with a simple template the problem is the tragedy of the commons and the solution is political institutions thus the tragedy of the commons is resolved by governing the commons in this paper we argue that there is also the possibility of a tragedy of governing the commons if political institutions lock participants into a certain pattern of resource use and then there is an exogenous shock say a technological change that increases the risks to one group then the situation may no longer be a classic common pool situation and institutions may actually exacerbate rather than ameliorate distributional conflict we develop a general model showing that whenever there is heterogeneity in private risks some technological innovation could potentially turn a previously stable institution into a source of conflict we take the compelling recent example of horizontal hydrofracturing changing the welfare implications of the institution of compulsory pooling and use a new individual level dataset of landowners affected by compulsory pooling in new york to demonstrate the empirical support for our model

species preservation versus development an experimental investigation under uncertainty the safe minimum standard sms is a decision rule to preserve renewable resources unless the social costs of doing so are intolerable while unpersuasive to many support for the sms has been advocated by some economists for settings involving irreversibility and a high degree of uncertainty the objective of this paper is to explore decision making involving species preservation versus development within an experimental laboratory setting and involving uncertainty the experimental design implements a number of prior game theoretic investigations of the sms bishop 1978 ready and bishop 1991 palmini 1999 involving insurance and lottery or combined games against nature the choices are between species preservation which possibly provides a cure for a disease or developing habitat leading to irreversible depletion econometric results from a random parameters logit model using responses from 117 participants across both u s and mexican university student samples and 9 treatment choices indicate that support for the sms varies across the type of game the imposed maximum regret condition concerning the relative magnitude of the costs of disease and net benefits of development a constructed measure of respondents risk aversion and other factors there is also strong evidence of unobservable heterogeneous preferences for preservation within our sample

environmental auditing in management systems and public policy abstract new international standards for environmental auditing are now being actively promoted by public authorities and adopted by private firms one important feature of these standards is their emphasis on managerial systems and incentives that support a wiser use of environmental resources this paper studies such a system in which incentive compensation may be based in part on the results of an environmental audit it is found that optimal wages after an environmental audit is performed should have a greater range than wages paid when no audit has occurred it is also shown that the decision to conduct an environmental audit and the size of the expected wage in this case depend crucially on whether the agent s prudence or precautionary motives dominates his aversion to risk it is finally found that the insertion of environmental audits within current management systems would certainly induce a manager to care more about the environment although this may come at the expense of less concern for other activities we find plausible circumstances in which properly designed environmental audits overcome such a tradeoff and increase the manager s attention tobothenvironmental and traditional tasks some implications of the analysis for environmental public policy are also discussed briefly

scientific progress and irreversibility an economic interpretation of the precautionary principle abstract we consider the problem of the optimal use of a good whose consumption can produce damages in the future scientific progress is made over time that provides information on the distribution of the intensity of damages we show that this progress induces earlier prevention effort only if prudence is larger than twice absolute risk aversion this paper thus identifies the class of quite restrictive but plausible conditions such that scientific uncertainties justify an immediate reduction of the consumption of a potentially toxic substance

justifying precautionary policies incommensurability and uncertainty abstract when decisions are taken in conditions of keynesian or knightian uncertainty and when there is a threat of serious or irreversible environmental damage the precautionary principle is often recommended to guide decision making however the precautionary principle has been widely criticised in response to these criticisms a qualitative version of the precautionary principle is developed which draws its normative content from a blend of formal decision theory and political philosophy it is argued that precautionary action can be justified by some flexible combination of uncertainty and incommensurability the greater the uncertainty the less incommensurability is required to justify precautionary action and vice versa throughout the paper the arguments are explored using the example of climate change decision problems

strategic information acquisition and the mitigation of global warming abstract we consider the strategic role of uncertainty and information acquisition for the mitigation of global warming before the countries decide on their contribution to a mitigation of global warming they may invest in information about the country specific benefit of reductions of the emissions of greenhouse gases we show that information acquisition has a substantial strategic value countries may prefer not to learn their benefit of climate protection even if information acquisition does not involve a direct cost this strategic information choice may further decrease the efficiency of the public good provision

specifications of social welfare in economic studies of climate policy overview of criteria and related policy insights an important assumption in economic studies of climate policy is the social welfare function this paper shows that applying distinct decision or social welfare criteria can result in different optimal policies of climate control notably if climate change impacts are uncertain first decision criteria in current climate economic studies are reviewed next the most important alternatives are discussed including their mathematical formalization and incorporation in economy climate models most of these alternative criteria suggest more stringent climate policies to be optimal than the standard discounted utilitarianism approach however several important welfare criteria have not or hardly seen any application in the economic analysis of climate policy we conclude that there is clear need for systematic research on this theme for which the current review provides a solid basis

taking one for the team is collective action more responsive to ecological change debate persists around the timing of risk reduction strategies for large scale ecological change for three reasons risks are difficult to predict they involve irreversibilities and they impact multiple jurisdictions the combination of these three factors creates a general class of filterable spatial dynamic externalities fsde in which one person s risk reduction investments reduce or filter undesirable events experienced by others and underestimates the option value placed on being able to respond to new information about the consequences of ecological change by focusing on the optimal intervention decision we illustrate how and when the opposing forces created by an fsde will lead to a divergence in private and collective risk reduction strategies we use bioinvasions as our motivating example the bioinvasion first hits one jurisdiction and that jurisdiction s risk reduction investment reduces the risk faced by all other jurisdiction we find that efforts to internalize the full benefits of risk reduction investments may have unintended consequences on the responsiveness of environmental policy there is a social welfare gain from asking the first jurisdiction to delay a risk reduction investment to internalize the option values of all at risk jurisdictions

repeated games with stochastic discounting this paper provides folk theorems for infinitely repeated games where the discount factor is stochastic when discount factors are independently distributed and the current discount fac tor is unobservable prior to current actions standard trigger strategies support a full folk theorem when the infimum of the mean of the sequence of discount factors is sufficiently close to one when players choose actions in each period after having observed the current discount factor this result breaks down payoffs on the boundary of the set of individually rational payoffs are unobtainable as nash equilibrium average payoffs to the supergame in order to highlight the impact of stochastic discounting on the analysis of supergames we provide the stochastic discounting analogue to friedman s perfect folk theorem this paper examines the implications of stochastic discount factors for nash equilibria in repeated games repeated games have broad applicability in olig opolistic markets where optimizing owners make decisions based on the expected present value of alternative actions in this setting firms can invest one dollar today at the present rate of interest to obtain principal and interest tomorrow thus it is natural to interpret the discount factor as 1 1 r where rt is the real rate of interest between periods t and t 1 the paper is motivated by recent evidence kinal and lahiri 1988 among others that the real rate of interest varies stochastically over time and the fact that the existing literature on repeated games assumes the discount factor to be deterministic our results are also relevant for finitely repeated games where the probability that the game ends owing to bankruptcy say varies stochastically over time our theorem 2 shows that when discount factors are independently dis tributed and the current discount factor is unobservable prior to current actions standard trigger strategies support a full folk theorem when the infi mum of the mean of the sequence of discount factors is sufficiently close to one theorem 3 demonstrates that when players choose actions in each period after having observed the current discount factor this result breaks down pay offs on the boundary of the set of individually rational payoffs are unobtain able as nash equilibrium average payoffs to the supergame the reason is that a sufficiently low realization of the discount factor induces players to behave myopically since in such periods the expected discounted value of sustaining one shot cooperative actions is arbitrarily low in order to highlight the impact of stochastic discounting on the analysis of supergames we provide in theorem 4 the stochastic discounting analogue to friedman s perfect folk theorem the supergame strategies we employ never break down and involve actions correlated with current realizations of the discount rate players revert to a one shot nash equilibrium for low realiza tions of the discount factor and return to one shot collusive behaviour for high realizations

voting on the budget deficit this paper analyzes a model in which a group of rational individuals votes over the composition and time profile of public spending all voters agree that a balanced budget is ex ante optimal however if there is disagreement between current and future majorities a balanced budget is not a political equilibrium under majority rule under certain conditions a majority of the voters favors a budget deficit and the equilibrium deficit is larger the greater is the polarization among voters copyright 1990 by american economic association

negotiated trade restrictions with private political pressure we consider a home government with political pressure to restrict trade the foreign country is compensated with a portion of the tariff revenues or quota rents but cannot directly observe the political pressure abroad in this setting the two countries negotiate over the volume of trade and transfer of rents depending on the level of political pressure we determine globally optimal incentive compatible trade policies in which the home government has no incentive to overstate or understate the pressure for protection

policy experimentation political competition and heterogeneous beliefs abstract we consider a two period model in which an incumbent political party chooses the level of a current policy variable unilaterally but faces competition from a political opponent in the future both parties care about voters payoffs but they have different beliefs about how policy choices will map into future economic outcomes we show that when the incumbent party can endogenously influence whether learning occurs through its policy choices policy experimentation future political competition gives it a new incentive to distort its policies it manipulates them so as to reduce uncertainty and disagreement in the future thus avoiding facing competitive elections with an opponent very different from itself the model thus demonstrates that all incumbents can find it optimal to over experiment relative to a counterfactual in which they are sure to be in power in both periods we thus identify an incentive for strategic policy manipulation that does not depend on parties having conflicting objectives but rather stems from their differing beliefs about the consequences of their actions

uncertainty learning and international environmental agreements the role of risk aversion this paper analyses the formation of international environmental agreements ieas under uncertainty learning and risk aversion it bridges two strands of the iea literature i the role of learning when countries are risk neutral ii the role of risk aversion under no learning combining learning and risk aversion seems appropriate as the uncertainties surrounding many international environmental problems are large often highly correlated e g climate change but are gradually reduced over time through learning the paper analyses three scenarios of learning a key finding is that risk aversion can change the ranking of these three scenarios of learning in terms of welfare and membership in particular the negative conclusion about the role of learning in a strategic context under risk neutrality is qualified when countries are significantly risk averse then it pays them to wait until uncertainties have been largely resolved before joining an iea this may suggest why it has been so difficult to reach an effective climate change agreement

bad eggs learning by doing and the choice of technology we model long run economic development through technology adoption under scientific uncertainty about environmental effects there are four possible long run equilibria in a socially planned economy high growth adopt rapidly but abandon damaging technologies once revealed ddt cfcs cautious brake the introduction of new technologies to avoid mistakes genetically modified organisms no growth halt technological progress to preserve secondary knowledge and collapse adopt rapidly without ever abandoning damaging technologies in the base parameterization a short sighted social planner chooses the cautious strategy a far sighted planner chooses the high growth strategy unless damages are irreversible in which case the cautious strategy again dominates regulatory options in the market economy are investigated pollution taxes do not affect the firm s level of precaution if they can only be applied after the adopting firm has reaped the benefits however they do encourage the abandonment of damaging technologies liability rules do affect precaution but may lead to excessive caution or even a no growth trap

the climate change learning curve abstract the purpose of this paper is to confront economic models of climate change with the reality that limited information exists with which to form expectations about the evolution of the climate a key element in the tension between those who believe we should impose aggressive climate change mitigation policies and those who do not is the question of if we are merely in a long period of shock induced above average temperatures or if observed increases in temperature are a result of carbon emissions this paper characterizes learning dynamics resulting from the use of observations of temperature to update beliefs about two key characteristics of global climate the persistence of natural trends and the sensitivity of temperature to atmospheric carbon levels this paper shows that contrary to predictions in the literature that uncertainty may be resolved very quickly the time to learn the true processes may be in the order of thousands of years further this paper shows the effects of uncertainty on the likelihood that observations from the statistical record lead to important estimate and policy errors

environmental risks and bank liability abstract many governments have introduced or are considering introducing laws to recover from the liable parties the cleanup costs caused by pollution damages in particular the banks who finance the firms causing environmental damages may be considered liable in various court cases in the us and elsewhere banks have been found liable while they have been exempted in others we develop a model in which the insurance sector may insure the firm for the pollution risk and the bank may lend money for investment under complete information of the bank about the firm s activities the limited liability of the firm induces excessive investment and insufficient care but full liability of the bank creates the appropriate internalization of the environmental risk this rationalization of the laws on lender liability must be qualified because in general the banks suffer from agency problems adverse selection and moral hazard in their relationships with firms in the adverse selection case full liability of the bank leads to underinvestment partial liability is better but may fail to implement the optimal second best allocation in the case of moral hazard full responsibility is killing the project too often while still leading to low care too often partial responsibility may achieve the second best optimal allocation but in some cases the level of responsibility necessary to induce the proper level of care is too high for the project to be financed by the bank we conclude with a discussion of the implications of our results with regards to liability laws for environmental damages

precautionary saving in the small and in the large the theory of precautionary saving is shown to be isomorphic to the arrow pratt theory of risk aversion making possible the application of a large body of knowledge about risk aversion to precautionary saving and more generally to the theory of optimal choice under risk in particular a measure of the strength of the precautionary saving motive analogous to the arrow pratt measure of risk aversion is used to establish a number of new propositions about precautionary saving and to give a new interpretation of the dreze modigliani substitution effect copyright 1990 by the econometric society

optimal dynamic trading with leverage constraints we solve for the optimal dynamic trading strategy of an investor who faces a leverage constraint i e a limitation on his ability to borrow for the purpose of investing in a risky asset we assume that the investor has constant relative risk aversion and that the value of the risky asset follows a geometric brownian motion in the absence of the leverage constraint the optimal strategy involves investing a fixed proportion of wealth in the risky asset we prove that in the presence of the leverage constraint the optimal investment also involves investing a fixed proportion of wealth in the risky asset when the leverage constraint is not binding however the two proportions are different reflecting the extent to which the investor alters his strategy even when the leverage constraint is not binding because of the possibility that the leverage constraint will become binding in the future

on the concavity of the consumption function at least since keynes 1935 many economists have had the intuition that the marginal propensity to consume out of wealth declines as wealth increases nonetheless standard perfect certainty and certainty equivalent versions of intertemporal optimizing models of consumption imply a marginal propensity to consume that is unrelated to the level of household wealth we show that adding income uncertainty to the standard optimization problem induces a concave consumption function in which as keynes suggested the marginal propensity to consume out of wealth or transitory income declines with the level of wealth