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Externalities in a Model of Perpetual Youth with Age-Dependent Productivity

Wendner, Ronald (2008): Externalities in a Model of Perpetual Youth with Age-Dependent Productivity.

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Abstract

This paper investigates the effects of (``keeping up with the Joneses'' and ``learning-by-investing'') externalities, when labor productivity decreases with age. Within the framework of a continuous time overlapping generations model, the effects of the consumption externality on the propensity to consume, capital level and individual consumption growth rates are ambiguous and depend on the presence (absence) and sign of the ``generation replacement effect'' (GRE). The sign of the GRE is determined by the rate at which labor productivity declines. Both externalities generate distortions --- even with exogenous labor supply. Depending on the sign of the GRE, in case of a production externality, the consumption externality may raise efficiency by introducing an additional distortion. For a specific rate of labor productivity decline the GRE vanishes. In this case, externalities display the same effects in both a representative agent and the overlapping generations model.

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