Strategic Interactions and Uncertainty in Decisions to Curb Greenhouse Gas Emissions

Abstract

This paper examines the strategic interactions of two large regions making choices about greenhouse gas emissions in the face of rising global temperatures. A focus is on three central features of the problem: uncertainty, the incentive for free riding, and asymmetric characteristics of decision makers. Optimal decisions are modelled in a fully dynamic, closed loop Stackelberg pollution game. Global average temperature is modelled as a mean reverting stochastic process. A numerical solution of a coupled system of Hamilton-Jacobi-Bellman equations is implemented and the probability distribution of outcomes is illustrated with Monte Carlo simulation. When players are identical, a classic tragedy of the commons is demonstrated compared to the outcome with a social planner. An increase in temperature volatility reduces player utility and increases the risk of the game, making cooperative action through a social planner more urgent. Asymmetric damages or asymmetric preferences for emissions reductions have important effects on strategic interactions of players. If one player experiences greater damages from global warming, the other player may increase or decrease emissions relative to the symmetric damages case, depending on the values of state variables. The same holds true if one player experiences an increase in green preferences.

Keywords: climate change, dynamic Stackelberg game, uncertainty, asymmetric players, HJB equation

JEL Classification: C73, Q52, Q54, Q58