Prices vs. Quantities: The Irrelevance of Irreversibility  Fridrik M. Baldursson University of Iceland, IS-101 Reykjavik, Iceland fmbald@hi.is Nils-Henrik M. von der Fehr University of Oslo, N-0317 Oslo, Norway nhfehr@econ.uio.no Abstract We explore the efficacy of price and quantity controls in a dynamic setup in which the decisions of some agents are irreversible. The assumption of irreversibility is shown to improve the performance of a tax relative to that of a system of tradable quotas and significantly alter the equilibrium behavior of agents. We nevertheless conclude that taking into account the fact that agents’ decisions may be irreversible does not lead to policy implications significantly different from those reached in a simpler model in which irreversibility is ignored. Keywords: Regulation; effluent taxes; tradable quotas; uncertainty; irreversibility; environmental management JEL classification: D81; D9; H23; L51; Q28; Q38 I. Introduction Recent research has shown that irreversibility matters; it matters for behavior at the micro level and it is a key concept in explaining many important, aggregate economic phenomena; see e.g. Dixit and Pindyck (1994). It therefore seems likely that irreversibility also matters for the choice of policy instruments. We examine this conjecture by re-examining the old question of ‘‘prices versus quantities?’’, as posed by Weitzman (1974) in his seminal study of optimal regulation. He studied the costs and benefits of two market- based instruments—taxes and quotas—in a static setup in which some amount of a certain good can be produced at a given cost, yielding well- defined benefits. In this setting, he demonstrated that uncertainty with respect to the costs of producing the good affects the choice between a * We are grateful to two anonymous referees, as well as to Tore Ellingsen, Michael Hoel, Karl O. Moene and seminar participants in Oslo, Reykjavik and Stockholm for useful comments on earlier versions of the paper. Financial support from Nordic Energy Research is gratefully acknowledged. Scand. J. of Economics 106(4), 805–821, 2004 DOI: 10.1111/j.1467-9442.2004.00379.x # The editors of the Scandinavian Journal of Economics 2004. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.