Consumption externality, efficiency and optimal taxation in one-sector growth model

Been Lon Chen*, Mei Hsu

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

2 Citations (Scopus)


In an economy with consumption externalities, existing studies find that a competitive equilibrium is efficient in the long run and remains efficient in transitions if preferences are homothetic. This paper revisits the efficiency issue in an otherwise standard one-sector growth model where consumption externalities affect a utility via their effects on the time preference. We find that even if preferences are homothetic, the externality changes the marginal rate of substitution between now and future and leads to a disparity in the intertemporal elasticity of substitution between the centrally planned economy and a decentralized economy. As a result, a competitive equilibrium is inefficient in transition dynamics. We characterize an optimal tax/subsidy structure that enables the allocation in a decentralized economy to replicate the social optimum.

Original languageEnglish
Pages (from-to)1328-1334
Number of pages7
JournalEconomic Modelling
Issue number6
Publication statusPublished - 2009 Nov
Externally publishedYes


  • Consumption externalities
  • Efficiency
  • Endogenous time preferences

ASJC Scopus subject areas

  • Economics and Econometrics


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