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Game Theory NCCR Hoel Presentation
Game Theory NCCR Hoel Presentation
Game Theory NCCR Hoel Presentation
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Concepts of game theory
− players
− strategies
− payoffs
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A simple pollution/abatement game
a d
A (0,0) (-1,1)
D (1,-1) (-L,-L)
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country 1: A or D
country 2. a or d
a d
A (0,0) (-1,1)
D (1,-1) (-L,-L)
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A more general pollution/abatement game
π j = I j − c ( a j ) − D (e)
where
Ij = GDP, assumed exogenous
Ej = business as usual (BAU) emissions (assumed exogenous)
ej = actual emissions (≤ Ej)
aj = Ej -ej = abatement, a j ∈ [0, E j ] ;
e = ∑ j e j = ∑ j ( E j − a j ) = sum of actual emissions
cj and Dj are increasing and convex, with c j '' > 0 and D j '' ≥ 0
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The first-best social optimum
0 0
A useful reference is the abatement levels 1( a ,..., a N ) and corresponding
sum of emissions e0 that maximize the sum of payoffs (often called the
social optimum). It is straightforward to see that these abatement levels
must satisfy (assuming an interior solution):
The first N-1 of these equations are the conditions for cost-effectiveness.
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The Nash equilibrium
* *
The Nash equilibrium is the abatement levels 1 ( a ,..., a N ) and
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Example:
N identical countries each with abatement cost and environmental cost
functions given by
a2
c(a) =
2 implying c '( a ) = a
which gives a 0
= Nb and a *
=b
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Carbon leakage
we get
da2 − D2 ''
= ∈ (−1, 0]
da1 c2 ''+ D2 ''
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Other reasons for carbon leakage:
- lower international prices of fossil fuels
- higher international prices of traded energy-intensive goods
Empirical estimates:
• most studies: between 5 and 25 percent; some studies: much higher
• smaller for large countries (or groups of countries)?
• may depend on type of climate policy (e.g. uniform versus
differentiated domestic taxes)
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Types of international climate agreements
a) On emission levels
b) On coordinated policy
c) On coordinated R&D efforts to reduce BAU emissions and/or
reduce abatement costs
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Quota trade. Let
e j = emission ceiling for country j
p = quota price (same for all countries, determined in international
market)
∑ j
e j ( p ) =∑ j e j
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To summarize:
− cost-effectiveness is achieved through quota trading
− overall level of emissions may be set so the social optimum is
achieved
− allocation of initial emission quotas determines how gains from
cooperation are distributed among countries
BUT:
Even if all countries are better off with agreement than without, each
country may be even better off if it does not cooperate, but the other
countries do. I.e. free rider incentive!
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Free riding and stable coalitions
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We shall demonstrate:
Under (a) the “grand coalition” (coalition of all countries) is stable for a
suitable distribution of initial quotas
Under (b) the maximal stable coalition is typically very small (only 3-4
countries if identical countries)
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Coalition of k countries (1<k≤N).
(
c '(a c ) = kD ' E − ⎡⎣ ka c + ( N − k )a n ⎤⎦ )
(
c '(a n ) = D ' E − ⎡⎣ ka c + ( N − k )a n ⎤⎦ )
π c
These equilibrium abatement levels give the equilibrium payoffs ( k )
and π ( k ) .
n
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Gamma-core
π c
Can show that ( k ) is increasing in k. This implies that the grand
coalition is stable: No group of k<N countries can improve these
countries’ payoffs by leaving the grand coalition and forming a sub-
coalition.
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Two-stage non-cooperative game
Stage 1: Define Φ (k ) = π (k ) − π (k − 1)
c n
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Example: cost functions as in previous example
a c (k ) = kb
a n (k ) = b
e(k ) = E − [ k (kb) + ( N − k )b ] = ( E − Nb) + bk (1 − k )
1 b2 2
π (k ) = I − ( kb) − b [ ( E − Nb) + bk (1 − k ) ] = const. + ( k − 2k )
c 2
2 2
2
1 b
π n ( k ) = I − (b) 2 − b [ ( E − Nb) + bk (1 − k ) ] = const. + ( k 2 − k − 1)
2 2
b2
Φ (k ) = ⎡⎣ 4k − k 2 − 3⎤⎦
2
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so
Φ (1) = 0
Φ (2) = 1
Φ (3) = 0
Φ (k ) < 0 for k>3
Note: Nash equilibrium is not unique; even for a given coalitions size
the equilibrium does not tell us which countries will be members. Note
in particular that π c
( k ) > π n
(k ) , so better to be outside than inside
coalition! (Game of chicken)
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Extensions/modifications
- farsightedness
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Endogenous technology
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Carbon leakage with exogenous technology:
Reduced emissions in country A => increased emissions in country B
due to
- increasing marginal environmental costs
- lower international prices of fossil fuels
- higher international prices of traded energy-intensive goods
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Sketch of a model (Golombek and Hoel):
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Model applied to carbon leakage
(when carbon leakage is zero if technology is exogenous):
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Model applied to international agreements:
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Agreement only on emissions (and not on R&D):
In stage 2 each country takes the abatement level a as given and R&D
expenditures x are determined non-cooperatively, i.e. each country
chooses its R&D to maximize its own payoff
π = I − c( a, x + exogenous ) − x − D (exogenous )
π = I − c ( a, y ( a ) ) − x ( a ) − D ( N ( E − a ) )
ca ( a 0 , y ( a 0 ) ) > ND ' ( N ( E − a 0 ) )
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A technology based climate agreement
- what exactly is such an agreement?
o an agreement leading to more abatement cost reducing R&D
than countries otherwise would have carried out
o could either focus directly on R&D investments or on policies
stimulating R&D
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A technology based climate agreement (cont.)
- is a technology agreement less vulnerable to free riding than a
“conventional” agreement?
o free rider incentive if potential free rider can obtain benefits
without paying costs
o likely to be similar in technology agreement as in conventional
agreement (Barrett, 2006)
o Buchner and Carraro (2005): technology spillovers only to
coalition members
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A technology based climate agreement (cont.)
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Background/references:
S. Barrett (2006), “Climate treaties and “breakthrough” technologies. American Economic Review 96 (2), pp. 22-25.
B. Buchner and C. Carraro (2005): “Economic and environmental effectiveness of a technology-based climate protocol”. Climate
Policy 4, 229-248.
R. Golombek and M. Hoel: “Unilateral Emission Reductions and Cross-Country Technology Spillovers”, Advances in Economic
Analysis & Policy: Vol. 4: No. 2, Article 3 (2004). (http://www.bepress.com/bejeap/advances/vol4/iss2/art3)
[Also printed as chapter 8 in D. Fullerton (ed.): The Economics of Pollution Havens, Edward Elgar, 2006.] Sections 4 and 6 may be
skipped.
R. Golombek and M. Hoel: “The Kyoto agreement and technology spillovers”. Memorandum from the Department of Economics, no
5/2005. (http://www.oekonomi.uio.no/memo/memopdf/memo0505.pdf)
M. Hoel (1997), "How Should International Greenhouse Gas Agreements Be Designed?", in P. Dasgupta ,K.-G. Maler and A.
Vercelli (eds.): The Economics of Transnational Commons , Clarendon Press, Oxford ; pp. 172-191. Section 7 may be skipped.
M. Hoel and K. Schneider, 1997, "Incentives to participate in an international environmental agreement", Environmental and
Resource Economics 9, pp.153-170. Sections 1-3.
R. Perman, Y. Ma, J. McGilvray and M. Common: Natural Resource and Environmental Economics, Pearson, 3rd edition, 2003.
Chapter 10 (“International environmental problems”)
H. Tulkens (1998), “Cooperation versus free-riding in international environmental affairs: two approaches”, in N. Hanley and H.
Folmer (eds.): Game Theory and the Environment, Edward Elgar, pp. 30-44.
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