Welfare Implications and Equilibrium Indeterminacy in a Two-sector Growth Model with Consumption Externalities

Abstract

One-sector neoclassical growth models reveal that consumption externalities lead to inefficient allocation in a steady state and indeterminate equilibrium toward the steady state only if there is a labor-leisure tradeoff. This paper shows that in a two-sector neoclassical growth model, even without a labor-leisure tradeoff, consumption spillovers easily lead to inefficient allocation in a steady state and indeterminate equilibrium toward the steady state. Consumption spillovers that yield over-accumulation of capital in an otherwise identical one-sector model may lead to under-accumulation of capital in two-sector models depending on relative capital intensities and relative degrees of externalities. Moreover, a two-sector model economy with consumption externalities is less stabilized than an otherwise identical one-sector model economy with consumption externalities.