Profit Maximization and Social Optimum with Network Externality

Abstract

We consider a set of countries that wish to sign an international agreement to control pollution. The problem is studied from the perspective of cooperative games and three possible definitions of the characteristic function of the game are analyzed. We further address the issue of free riding and the stability of coalitions. The challenge is to find a possible reconciliation of the two approaches. In other words, we are looking for a payment function which ensures the formation and stability of a large coalition, even if we consider that different countries are playing non-cooperatively and are acting only in their own interest. Our results suggest that it is difficult to deter free riding and that no large coalition can emerge if countries decide to play non-cooperatively.