We consider a non-cooperative three-stage game played by two regulator-firm hierarchies. We suppose that raising public funds is socially costly and that market sizes are large enough. Contrary to what might be expected, we show that opening markets to international trade increases the per-unit emission-tax and decreases the per-unit R&D subsidy. It also increases the R&D level, production, and pollution when the marginal damage of pollution is sufficiently high, and, consequently, decreases the emission ratio and the social welfare. However, we think that these results might change if the market sizes are not too large or if we introduce asymmetric information.
Group for Research in Decision Analysis