Pricing instruments in environmental and climate policy when polluters are boundedly rational

Area of Science:

• Environmental Economics
• Behavioral Economics
• Climate Policy

Background:

• Pricing instruments are advocated for environmental policy due to efficiency and scope.
• Skepticism persists regarding their performance, particularly from social environmental sciences.
• Traditional economic arguments for pricing instruments often assume rational agents.

Purpose of the Study:

• To present a comprehensive case for price-based environmental policy instruments.
• To evaluate pricing instruments under behavioral economics assumptions, including bounded rationality.
• To compare the effectiveness of cap-and-trade versus environmental taxation in climate policy.

Main Methods:

• Adopting a broad perspective on arguments for price-based instruments.
• Examining instrument behavior under realistic behavioral assumptions (bounded rationality, other-regarding behavior).
• Assessing criticisms related to rational agent assumptions in economic models.

Main Results:

• The case for cap-and-trade systems is strengthened over environmental taxation when considering behavioral factors.
• Traditional economic arguments for pricing instruments are challenged by behavioral economics findings.
• Additional instruments may be needed to address climate challenges under bounded rationality.

Conclusions:

• Price-based instruments, especially cap-and-trade, can be effective environmental policy tools, even with behavioral considerations.
• Addressing skepticism requires acknowledging and integrating insights from behavioral economics.
• Policy design must account for bounded rationality and social interactions for optimal climate outcomes.