Distinguish between a price instrument and a quantity instrument in terms of DWL and flexibility.

• A. Price instruments are always more efficient than quantity instruments.
• B. Price instruments are more predictable for revenue but may cause more DWL if prices are misaligned; quantity instruments fix output but can lead to price volatility.
• C. Price instruments guarantee zero DWL.
• D. Quantity instruments remove price volatility completely.

Answer: (B)

The main idea here is how price-based versus quantity-based policies handle efficiency losses and price stability. Price instruments, like taxes, set the price faced by buyers and sellers and let the quantity adjust. They’re flexible because changes in demand or supply automatically shift the actual output without new policy steps, and the government can collect revenue from the tax. But this flexibility comes with a potential downside: if the tax level isn’t aligned with the true social marginal damage, the resulting output diverges from the efficient level, creating deadweight loss.

Quantity instruments, like quotas or caps, fix the total quantity allowed. This can tightly control the level of output and, if set correctly, minimize DWL at the target level. However, because the price of permits is determined by market forces, the price can become volatile as supply and demand shift, leading to price swings that can be costly or uncertain for stakeholders.

So the best choice captures this trade-off: price instruments provide revenue predictability but can generate more DWL if the price is misaligned with social optimality; quantity instruments fix output but can cause price volatility. The other options aren’t accurate because they overstate guarantees (zero DWL) or claims about removing volatility entirely, which aren’t true in practice.