Subgame consistent cooperative provision of public goods

Abstract

The provision of public goods constitutes a classic case of market failure which calls for cooperative optimization. However, cooperation cannot be sustainable unless there is guarantee that the agreed-upon optimality principle can be maintained throughout the planning duration. This paper derives subgame consistent cooperative solutions for public goods provision by asymmetric agents with transferable payoffs in a stochastic differential game framework. In particular, subgame consistency ensures that as the game proceeds agents are guided by the same optimality principle, and hence they do not possess incentives to deviate from the previously adopted optimal behavior. A “payoff distribution procedure” leading to subgame-consistent solutions is derived and illustrative examples are presented. This is the first time that subgame consistent cooperative provision of public goods with transferable payoffs is analyzed.