Government optimal long run policy - Nash equilibrium
The government's optimal long run policy is associated with policy coordination at point C. However, as in the static model, governments may have a short run incentive to deviate from this outcome. This problem is particularly severe when the game is known to be played only a finite number of times. In this situation backward induction predicts that all countries will pursue the Nash equilibrium every time period. This prediction appears to rule out the possibility of effective policy coordination. Fortunately a number of ways have been suggested for how government might overcome this problem of sustainability.