The project aims to describe firms' production and innovation decisions theoretically, accounting for the interdependence between firms' market strategy and governments' environmental regulation decisions. This project complements and expands the work carried out in contract no: 92 - 0159.

Attention is devoted to both the economic and technological aspects of the problem, in particular the role of environmental innovation and the nature of the "Best Available Technology" choice. The following are addressed:

i) technological innovation by the firm and its effects on consequential environmental damage;

ii) the likelihood of polluting firm relocation as a consequence of environmental regulation;

iii) the possibility of firms' products being environmentally differentiated;

iv) the nature of the policies which integrate environmental and industrial policies in non-competitive, oligopolistic industries.

The international interaction of firms is described through the process of trade in the international goods market. The study examines the effect of unilateral and internationally coordinated environmental policy measures. The model takes account of market imperfection and informs the policy context by characterising the strategic reaction of firms (in terms of production, product differentiation, technological innovation, location, etc.) made in reaction to environmental regulation.