Welfare Implications of the Interaction between Habits and Consumption Externalities

• Authors: Jordi Caballé.
• BSE Working Paper: 110598 | September 15
• Keywords: habit formation , consumption externalities
• JEL codes: D91, O40
• habit formation
• consumption externalities

We analyze the welfare properties of the equilibrium path of a growth model where both habits and consumption externalities affect the utility of consumers. Our analysis highlights the crucial role played by complementarities between externalities and habits in order to generate an inefficient dynamic equilibrium. In particular, we show that the competitive equilibrium is inefficient when consumption externalities and habit adjusted consumption are not perfect substitutes.