The Pollution Game

An important example, similar in structure to the prisoner’s dilemma, is the pollution game shown in Figure 11-7. Consider an economy with externalities such as pollution. In a world of unregulated firms, each profit-maximizing firm would prefer to pollute rather than install expensive pollution-control equipment. Moreover, any firm which behaves altruistically and cleans up its wastes will have higher production costs. higher prices, and fewer customers. If its costs are high enough. the firm may even go bankrupt., The pressures of Darwinian competition will drive all firms to the starred Nash equilibrium in cell ‘D in Figure 11-7; here neither firm can improve its profits by lowering pollution.

The pollution game is an example of a situation in which the invisible-hand mechanism of efficient perimeter competition .breaks down. This is a ritualism in which the noncooperation or Nash equilibrium When the Nash equilibrium become dangerously inefficient, governments may step in. By setting efficient regulations or emissions. charges, or perhaps, by establishing efficient property rights. government can induce firms to move to outcome A. the “low pollute; low-pollute” world. In that equilibrium. the firms make the same profit as in the high-pollution world, and the earth is a healthier place to live in.

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