Achieving international cooperation in addressing the prospect of climate change is no easy feat. There may be strong incentive problems, as the following problem demonstrates. Consider three major potential parties to an international agreement: the U.S., Europe (here regarded as a bloc) and China. Let the U.S. be denoted by the subscript "1", Europe by "2", and China by "3". Suppose the marginal costs and benefits of greenhouse gas emissions are as follows:

Abatement costs

MB1 = 60 - E1	MB2 = 60 - E2 Greenhouse damages MD2,2 = 10 MD2,1 = 20 MD2,3 = 10	MB3 = 60 - E3	own: exported: exported:
MD1,1 = 20 MD1,2 = 10 MD1,3 = 10	MD3,3 = 10 MD3,1 = 20 MD3,2 = 10

Here Ei denotes the emissions by region i. MBi is the marginal benefit to region i of its own emissions i. (This is also country i's marginal cost of abatement schedule.) MDi,j signifies the marginal environmental (climate-change-related) damages imposed by country i on country j.

a. If each region acts unilaterally to maximize its own welfare, what levels of emissions will each choose? What is the benefit to each country associated with its own unilateral action (relative to no abatement)? How much do Europe and China benefit from the U.S. unilateral emissions policy?

b. If all three regions act to maximize their combined welfare, what levels of emissions will be chosen? Relative to the case where all countries pursue unilateral policies, what is the additional gain to each region from policy coordination? Why does the U.S. gain more from coordination than the other two countries?

c. Can you devise a circumstance under which (absent side payments) one of the three countries would be worse off after coordination?

d. Suppose that Europe and China cooperate but the U.S. free rides (pursues the unilateral policy). Assuming no retaliation by the other countries (and ignoring political costs), what is the gain to the U.S. from free riding relative to cooperating with the other countries?

e. How might the temptation to free ride be related to the size of a given country? How can incentives to free-ride be overcome?