Cross-border pollution, terms of trade, and welfare

We construct a two-good general equilibrium model of international trade for two small open economies where pollution from production is transmitted across borders. Governments in both countries impose emission taxes non-cooperatively. Within this framework, we examine the effect of changes in the degree of cross-border pollution on Nash emission taxes, emission levels and welfare. We do so under two scenarios: when changes in cross-border pollution do not affect domestic pollution (non-strategic) and when they do (strategic). We also examine the effect of changes in international terms of trade on pollution and welfare when cross-border pollution is non-strategic.