Transboundary Pollution Abatement, Emission Permits Trading and Compensation Mechanism: A Differential Game Analysis

Abstract

In this paper, we consider a pollution control problem along a river basin where a portion of the pollution emitted by the upstream region can be transferred to the downstream region. Our model has three significant features: first, we take into account the pollution abatement investment, and the stock of pollution abatement capital follows standard differential equation of motion; second, we introduce the emission permits trading system so that each region has the choice between buying pollution permits or pollution abatement investment; third, we consider the pollution compensation mechanism so that the downstream region pays pollution compensation for the upstream region. We explore and compare the optimal decisions of both the upstream and downstream regions under the cases of the cooperative and no-cooperative strategies, respectively. We find that although the flow of emissions can be better controlled by cooperation between the upstream and downstream regions, the pollution abatement investment is not necessarily higher in the cooperative equilibrium. Further, a sensitivity analysis is also conducted on the parameters of the transboundary river basin pollution.