Negotiation and Optimality in an Economic Model of Global Climate Change

The paper addresses the problem of governmental intervention in a multi-country regime of controlling global climate change. Using a simplified case of a two-country, two-sector general equilibrium model the paper shows that the global optimal time path of economic outputs and temperature will converge to a unique steady state provided that consumers care enough about the future. To answer a set of questions relating to 'what will happen if governments decide to correct the problem of global warming?' we study the equilibrium outcome in a bargaining game where two countries negotiate an agreement on future consumption and production plans for the purpose of correcting the problem of climate change. It is shown that the agreement arising from such a negotiation process achieves the best outcome and that it can be implemented in decentralised economies by a system of taxes, subsidies and transfers. By employing the recent advances in non-cooperative bargaining theory, the agreement between two countries is derived endogenously through a well-specified bargaining procedure.