Think of the problem of climate change as a game between two countries called China and the US, considered as if each were a single individual. Each country has two possible strategies for addressing global carbon emissions: Restrict (taking measures to reduce emissions, for example by taxing the use of fossil fuels) and BAU (the Stern report's business as usual scenario). Figure 4.17 describes the outcomes (top) and hypothetical payoffs (bottom), on a scale from best, through good and bad, to worst. This is called an ordinal scale (because all that matters is the order: whether one outcome is better than the other, and not by how much it is better).
Figure 4.17 Climate change policy as a prisoner's dilemma (top). Payoffs for a climate change policy as a prisoner's dilemma (bottom left), and payoffs with inequality aversion and reciprocity (bottom right).
1) Show that both countries have a dominant strategy. What is the dominant strategy equilibrium?
2) The outcome would be better for both countries if they could negotiate a binding treaty to restrict emissions. Why might it be difficult to achieve this?
3) Explain how the payoffs in the bottom right of Figure 4.17 could represent the situation if both countries were inequality averse and motivated by reciprocity. Show that there are two Nash equilibria. Would it be easier to negotiate a treaty in this case?
4) Describe the changes in preferences or in some other aspect of the problem that would convert the game to one in which (like the invisible hand game) both countries choosing Restrict is a dominant strategy equilibrium.
US
Restrict
BAU
Reduction in
US free rides on emissions sufficient Restrict to moderate Chinese emissions climate change cutbacks
China China free rides on BAU US emissions cutbacks
No reduction in emissions
GOOD
GOOD
GOOD
WORST
BEST
WORST
WORST