Theories of international trade support the assumption that relatively strict environmental policies can have a strong impact on production and foreign trade. Nevertheless, empirical studies present mixed results. This paper links two previous econometric approaches of environmental-policy-trade relationship, namely Larson (2000) and Jaffe et al. (2002). The Larson approach involves a partial equilibrium model that estimates the percentage change in output, exports and/or imports due to some changes in production costs caused by complying with a higher environmental standard. The Jaffe et al. (2002) approach however, suggests that market-based instruments create more efficient incentives for firms to comply with the environmental policies than command-and-control policies and introducing uncertainty and statistical errors to the compliance costs. The application of the Larson model requires that the compliance cost of the proposed environmental standard to be known constant. In this paper, a statistical model has been developed by incorporating those principles of Jaffe et al. (2002) in the Larson model at the sector level. The Larson model was applied to conduct at firm level analysis of trade and environmental linkages in reference to proposed environmental standards or a generic increase in the firm's production costs. Using the modified model, we compare the effects of direct regulations and of adoption of subsidies at the sector level assuming uncertainty in the firms' compliance costs. The aim of this is to study the impact of environmental policies that will be considered for adoption by the Palestinian National Authority on trade and production of specific Palestinian economic sectors in the Gaza Strip.

Key words: equilibrium models, uniform distribution, trade and environment, compliance costs, environmental policies.