If the government has not set an environmental standard but a tax, emissions, e0, may change as a response to international trade. In addition to equations (4.3) and (4.4), (4.5) has to be taken into account. Moreover, the simplifying assumption is used that the other country does not change its own emissions of toxic substances. Thus, of each unit of waste exported (1 - S)A units spoil the domestic environment. This is a small- country assumption. Total differentiation yields:(4.A1)
and the comparative statics are, (4.A2a) (4.A2b) (4.A2c)
The welfare effect is. (4.A3)
If the environmental policy is optimal, equation (4.9) can be used to substitute for sag′ ƒu1 + sau2. Rearranging terms then yields. (4.A4)
The first term is negative. It measures the impact of the transport costs and the pollution spillover. The second term is positive. It measures the efficiency gain. If the transport costs and transfrontier pollution problems are sufficiently low, there will be welfare gains.
For the foreign country, we obtain(4.A1′)