Figure 4. The set of separating equilibrium outcomes
The main findings of this section the following proposition summarizes:
Proposition 2: Given A1-A4 and the SCC, when costs are fully correlated, but
no country initially is informed about the true cost level, and a
country can be fully informed, then qu > q(L,1), qH = q(H,0),
and the response by the uninformed countries are also to in-
creased reductions.
Hence, the reduction of each country is higher and in this case unilateral action
clearly has a potential to move the countries’ reduction levels in the right direc-
tion (seen both from an environmental and an economic point of view), com-
pared to the result in Hoel (1991). Note that the reason for unilateral action is
the inability of a low cost country to verify its costs unless it engages in costly
activity that convinces the other countries about its true type. Hence, unilateral
actions are a consequence of an adverse selection problem and the incentives
(for a high cost type) to misrepresent the true costs. Note that given assumption
A3a and A3b, it is also profitable for a country to undertake unilateral actions,
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