Consider a situation with two countries that have abatement cost functions :

for j=L and j=H. The countries have identical damage functions D(E)= d.E. For each country the parameters s_j are drawn independently from an identical Bernoulli distribution, with probabilities π_L and (1−π_L) for high and low values of s, respectively. The countries do not know each other’s abatement cost parameters. Derive the ex ante, second-best optimal contract, such that both countries would agree on the contract.

Possible transfer payments between countries must sum to zero. How must the mechanism be modified when D(E)=0.5-d-E²?

Transcribed Image Text:

C(e,s;)=0.5 (s; - e)