Strategic Behavior and the Environment > Vol 4 > Issue 1

Regulating Environmental Externalities through Public Firms: A Differential Game

Davide Dragone, Department of Economics, University of Bologna, Italy, , Luca Lambertini, ENCORE, University of Amsterdam, The Netherlands, , Arsen Palestini, MEMOTEF, Sapienza University of Rome, Italy,
Suggested Citation
Davide Dragone, Luca Lambertini and Arsen Palestini (2014), "Regulating Environmental Externalities through Public Firms: A Differential Game", Strategic Behavior and the Environment: Vol. 4: No. 1, pp 15-40.

Publication Date: 22 Apr 2014
© 2014 D. Dragone, L. Lambertini and A. Palestini
Environmental Economics,  Industrial organization,  Economic theory
Pollutionpublic firmsoligopolyMarkov perfect strategy


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In this article:
1. Introduction 
2. The Setup 
3. Social Planning 
4. The Mixed Market 
5. The Cournot-Nash Game Among Profit-Seeking Firms 
6. Policy Assessment 
7. Conclusions 


We investigate the possibility of using public firms to regulate polluting emissions in a Cournot oligopoly where production generates pollution and public firms are less efficient than private ones. In a differential game we compare (i) the Markov-Perfect Nash equilibrium under social planning; (ii) the Markov Perfect Nash equilibrium in a mixed setup where public firms coexist with profit-seeking agents; (iii) the Cournot-Nash game among profit-seeking firms. In a mixed market, profit-seeking firms internalize the externality generated by production, and social welfare is the highest. We conclude that the creation of a mixed market can be desirable for the regulation of environmental externalities.