A new approach to measuring shadow price: Reconciling engineering and economic perspectives

Abstract

Shadow price is one of the most important pieces of information in environmental decision making. Two different approaches—namely, economic and engineering—have been applied to obtain the shadow price of undesirable outputs, while using different methodological backgrounds and perspectives. The current study proposes a new conceptual framework and an economic estimation model to reconcile the shadow price estimates derived via the two approaches. We also suggest a new mapping rule that incorporates the concept of abatement level, which is a basic element in the engineering approach. As a result, the proposed model generates continuously changing estimates—i.e., comprising a shadow price curve—based on the abatement level. We further investigate the determinant factors of shadow price by using second-step regression. The suggested methodology is used to investigate the shadow price of carbon emissions in South Korean electricity generating plants, thus yielding relevant policy implications.