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Consumption Externalities, Production Externalities, and Efficient Capital Accumulation under Time Non-Separable Preferences

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  • Stephen Turnovsky
  • Goncalo Monteiro

Abstract

We examine the effects of both consumption and production externalities on capital accumulation and economic performance under time non-separable preferences and a non-scale production technology. We show that a consumption externality in isolation has long-run distortionary effects if and only if labour is supplied elastically. With fixed labour supply, it has only transitional distortionary effects, though it may generate long-run distortions through its interaction with the production externality. Production externalities always generate long-run distortions, irrespective of labour supply. The optimal taxation to correct for the distortions is characterized. Further quantitative insights are obtained by supplementing the theoretical analysis with numerical simulations based on the calibration of a plausible macroeconomic growth model.

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Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2006-26-P.

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Date of creation: Dec 2006
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Publication status: Published in European Economic Review, Volume 51, 2007, 479-504
Handle: RePEc:udb:wpaper:uwec-2006-26-p

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