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Consumption Externalities, Habit Formation and Equilibrium Efficiency

Jaime Alonso-Carrera, Jordi Caballé and Xavier Raurich
The Scandinavian Journal of Economics
Vol. 106, No. 2 (Jun., 2004), pp. 231-251
Published by: Wiley on behalf of The Scandinavian Journal of Economics
Stable URL: http://www.jstor.org/stable/3440932
Page Count: 21
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Consumption Externalities, Habit Formation and Equilibrium Efficiency
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Abstract

We analyze the welfare properties of the competitive equilibrium in a capital accumulation model where individual preferences are subject to both habit formation and consumption spillovers. Using an additive specification for preferences, according to which the argument in the utility function is a linear combination of present and past values of own consumption and consumption spillovers, we analyze the circumstances under which these spillovers are a source of inefficiency. It is shown that consumption externalities have to interact with habits in order to generate an inefficient dynamic equilibrium. Finally, we characterize optimal tax policies aimed at restoring efficient decentralized paths.

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