Noncooperative Regulation of a Nonlocalized Externality

With a nonlocalized pollution externality, different groups bear the costs and benefits of abatement. In the case of acid rain these groups are, respectively, consumers in the Midwest and pollutees in the Northeast. These groups have conflicting interests that are represented respectively by a public utilities commission and an environmental regulator. We analyze a model in which the Environmental Protection Agency, acting as a von Stackelberg leader, regulates pollution, and the public utility commission regulates the price for a monopolist that has private information about the effectiveness of its abatement alternatives. We characterize a noncooperative equilibrium and compare it with a cooperative equilibrium.