Essays in Honour of Peter Lloyd, Volume I
Edited by Sisira Jayasuriya
Chapter 9: Consumption and production externalities in a small open economy with accumulating capital
9. Consumption and production externalities in a small open economy with accumulating capital* Stephen J. Turnovsky and Wen Fang Liu 1. INTRODUCTION The role of distortions in international economies was an early interest of Peter Lloyd during the period that he and one of the present authors (Stephen Turnovsky) were colleagues at the Australian National University. Distortions may manifest themselves in diverse ways and Peter’s research focused on the role of taxes and subsidies; see Lloyd (1973, 1974). Recently there has been a surge of interest in the eﬀects of distortions arising through the presence of externalities. At issue here is the failure of agents to recognize their individual contributions to the collective economic environment, which in turn inﬂuences their own behaviour. Indeed, externalities are an integral aspect of a modern interdependent economy. The fact that households interact with one another makes it inevitable that their choices will inﬂuence one another directly, in addition to any impact that may occur through the marketplace. Economists are, of course, well aware of this phenomenon and the role of externalities has been widely studied in a variety of contexts. Externalities can be usefully categorized as being consumption externalities, on the one hand, and production externalities, on the other. Consumption externalities have been extensively studied in the context of models of ‘jealousy’ and ‘keeping up with the Joneses’. For example, Abel (1990) and Gali (1994) studied the eﬀects of consumption externalities on asset pricing and the equity premium, while Ljungqvist...
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