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.environmental game, climate change, international cap and trade system, national emission quotas, global emission cap, normalized equilibria, variational and quasi-variational inequalities.