Microeconomic models of a production economy with environmental externalities

Abstract

The environmental issue has surely become a central theme in the economic debate. From one side, this is analysed through large empirical models, solved numerically, that describe explicitly production and consumption\utility functions. On the other side, when environmental problems have a multinational dimension or, simply, involve a multiplicity of stakeholders, the game theoretical approach, focused on the strategic dimension of this problem, offers analytic solutions based on simple utility functions having only pollution and\or abatement as arguments. Although there are examples of large-scale empirical models taking into account game theoretical insights, the diversity in representing the same problem constitutes a gap for these two economic approaches to find a better integration. The present paper tries to bridge the mentioned gap by offering a family of models enough simple to be solved analytically, but where production and consumption, together with environmental aspects, are explicitly portrayed. Although the paper does not tackle directly the game theoretical aspect, the aim of the proposed family of models is to be used in game theoretical analysis in order to improve their representation of the economic–environmental linkage. Furthermore, in the proposed models, the negative consequences of pollution are divided into their detrimental effect on production activities and on utility. This last aspect is modelled in a novel way through the direct introduction into the utility function of an hypothetical environmental good whose consumption’s possibilities are diminished by pollution.