Groupe d’études et de recherche en analyse des décisions

G-99-28

Incentive Equilibrium Strategies and Welfare Allocation in a Dynamic Game of Pollution Control

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The paper considers two neighboring countries wishing to make a joint effort to control pollution emission. We use a differential game model that includes emission and investment in abatement technology as control variables. First, a coordinated solution that maximizes joint welfare is derived. Then we show that this outcome can be achieved as an incentive equilibrium in which each country uses an emission strategy that is linear in the other country's emission level. Further, we study the bargaining problem for allocating the joint welfare between the two countries, where the status quo is given by the open-loop Nash equilibrium. Finally, we design a mechanism for allocating over time the individual total welfare which ensures that each player instantaneous welfare under cooperation is higher than its non cooperative counterpart at any instant of time.

, 14 pages