Abstract
We study a trade‐off between economic and environmental benefits using a two‐stage optimal control setting where the player can switch to a cleaner technology that is environmentally ‘efficient’ but economically less productive. We provide an analytical characterization of the solution paths for the case where the considered utility functions are increasing and strictly concave with respect to consumption and decreasing linearly with respect to the pollution stock. We establish that in this context, an isolated player will either immediately start using the cleaner technology or for ever continue applying the old ‘dirty’ technology. In a two‐player dynamic game (between two neighboring countries) where the pollution results from a sum of two consumptions, we prove existence of a Nash (open‐loop) equilibrium, in which each player chooses the technology selfishly, i.e., without considering the choice made by the other player. A Stackelberg game solution displays the same properties. Under cooperation, the country reluctant to adopt the clean technology under autarky will adopt the cleaner technology provided it benefits from some ‘transfer’ from the more environment‐friendly partner. Copyright © 2010 John Wiley & Sons, Ltd.