Question 1 (10 marks): Suppose country A and country B are deciding whether to install new...

Question 1 :

Suppose country A and country B are deciding whether to install new incinerator to reduce regional air pollution or not. The new incinerators can reduce the domestic pollution and the cross-border pollution that affects both countries.

To quantify the analysis, suppose that if country A installs the new incinerator, it generates benefit of $1 million from reducing domestic pollution and of $1 million from reducing cross-border pollution. But, the benefit from reducing cross-border pollution will be equally shared by two countries. So, country A and country B will get a benefit of $0.5 million from reducing cross border pollution if country A installs the new incinerator.

The same calculation applies to country B. In other words, the new incinerator generates $1 million benefits domestically in B, and $1 million shared benefits to both A and B (each country gets $0.5 million)

a) Suppose that there is no cost in installing the new incinerator. Draw the game matrix and determine the equilibrium.

b) Suppose that the cost of installing the new incinerator is $2 million, draw the game matrix again. What is the implication from the equilibrium?

Expert Solution

Rahul Sunny answered 2 years ago

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