A Mechanism for Internalizing Externalities

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Global environmental change is a prime example of what economists can al externality. Each country may produce emissions which affect the welfare of all other countries. In choosing an appropriate level of emissions, each country will take into account the costs it imposes on itself, but may neglect or minimize the importance of the costs it imposes on others. Even if the magnitude of the potential cost are well-understood to the afflicted parties, it may be difficult to design an appropriate regulatory mechanism, if the regulator doesn't have access to such cost information. This project is concerned with the theoretical and experimental investigation of compensation mechanisms, a new class of mechanisms for internalizing externalities. The project investigates several theoretical extensions of these mechanisms, paying particular attention to different information structures. These mechanisms are also tested in the laboratory to see how they work in practice.