In the literature on environment and the international economy, international trade
and trade policies play key roles (see, for example, Copeland (1994) and Beghin et al
(1997)). In our analysis, international linkages come via cross-border pollution and
transfers. We assume both countries to be small open economies so that the commodity
prices are exogenous and we do not consider trade polices. Instead, we allow the donor
country to determine endogenously the amount of aid, and the recipient country is free to
choose the emission tax rate and how much of the aid it wants to allocate for public
abatement of pollution.