Consumption Externalities in a Ramsey Model

This chapter studies the e¤ect of consumption externalities on stability properties of a Ramsey model with heterogeneous agents and borrowing constraints. Agents di¤er in their initial wealth, felicity functions and discount factors. For simplicity, heterogeneity is reduced to two groups. Agents are identical within each group. In order to capture the role of heterogeneity as well as external e¤ects, we introduce intergroup and in- tragroup consumption externalities. In this setting, we show that the most patient agent holds the entire capital stock at the steady-state whereas the other agent (impatient) consumes his wage-income. Our main result is that, whenever the preferences display keeping up with the Joneses feature with respect to intergroup externalities, the appearance of two-period cy- cles does not require the relaxation of Income Monotonicity Assumption. Instead, only the external e¤ects in consumption from the other group that plays a crucial role for the appearance of these cycles.