Global Emission Ceiling versus International Cap and Trade: What is the Most Efficient System when Countries Act Non-cooperatively?

We model climate negotiations as a two-stage game. In the first stage of the game, players have to agree on a global emission cap (GEC). In the second stage, they non-cooperatively choose either their emission level or their emission quota, depending on whether emission trading is allowed, under the cap that potentially binds them together. A three heterogenous player quadratic game serves as a base for the analysis. In this framework, when the cap is non-binding, there exists a unique Nash equilibrium. When the emission cap is binding, among all the coupled constraints Nash equilibria, we select a normalized equilibrium by solving a variational inequality, which has a unique solution. In both scenarios – with and without emission trading – we show that there exists a non- empty range of values for which setting a binding cap improves all players’ payoff. It also appears that for some values of the cap, all players get a higher payoff under the GEC system alone than under the international cap and trade (ITC) system alone. Thus, the introduction of a GEC outperforms the ITC system both in terms of emission reduction and of payoff gains.