Welfare Implications and Equilibrium Indeterminacy in a Two-Sector Growth Model With Consumption Externalities

Abstract

In one-sector neoclassical growth models, consumption externalities lead to an inefficient allocation in a steady state and indeterminate equilibrium toward a steady state only if there is a labor-leisure trade-off. This paper shows that in a two-sector neoclassical growth model, even without a labor-leisure trade-off, consumption spillovers easily lead to an inefficient allocation in a steady state and indeterminate equilibrium toward a steady state. Negative consumption spillovers that yield ove-accumulation of capital in a one-sector model may lead to underaccumulation or overaccumulation of capital in two-sector models, depending on the relative capital intensity between sectors. Moreover, a two-sector model economy with consumption externalities is less stabilized than an otherwise identical one-sector model economy.