Incentive equilibrium strategies and welfare allocation in a dynamic game of pollution control

This paper considers two neighboring countries wishing to make a joint effo rt to control pollution emission. We use a differential game model that inc ludes emissions and investments in abatement technology as control variable s. First, a coordinated solution that maximizes joint welfare is derived. T hen we show that this outcome can be achieved as an incentive equilibrium i n which each country uses an emission strategy that is linear in the other country's emission level. Further, we study the bargaining problem of alloc ating the joint welfare between the two countries, where the status quo is given by an open-loop Nash equilibrium. Finally, we design a mechanism for allocating over time the individual's total welfare such that each player i nstantaneous welfare under cooperation is higher than his noncooperative we lfare at any instant of time. (C) 2000 Published by Elsevier Science Ltd. A ll rights reserved.