The Governmental Activity and Private Capital Investment

This paper analyzes in the context of a dynamic model, how firms decide on capital investment if the accompanying adjustment costs are a function of the governmental activity. The government provides the public input and decides on the degree of rivalry. The productive public input enhances private capital productivity and reduces the adjustment costs. An equilibrium in which capital and investment ratio are both constant is derived; comparative dynamic analysis is carried out; and policy implications of the model are discussed. Increasing the amount of the public input unequivocally spurs the capital investment, whereas the result becomes ambiguous with respect to the impact of rivalry. Since a reduction in congestion increases the individually available amount of public input, crowding out effects may lead to a reduction in the equilibrium capital stock. Although most of the analysis is conducted in the context of general production functions, the case of Constant Elasticity of Substitution (CES) production function is exclusively considered.