Dynamic Growth Games with Externalities
We examine the dynamics growth in a simple economy with two industrial sectors that exert externalities on each other. We find a solution to the dynamic game that ensues between the two sectors and compare it to the efficient cooperative solution. We show that internalize the externality. The direction of the inefficiency depends on the sign of the externality. We also examine the growth rates of the two sectors in this economy, focussing on the production functions. Unless the interaction parameters are identical, one of the sectors will eventually dominate the economy. We also show that as the number of sectors grows, the solution approaches the standard case where the sectors do not internalize the externality at all and this model represents a case intermediate between the usual cases of total and no internalization.
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