Dynamic Efficiency without Increasing Returns: Intertemporal Externalities in Competitive Economies

Singh, Jaspal (2026): Dynamic Efficiency without Increasing Returns: Intertemporal Externalities in Competitive Economies.

Abstract

This paper develops a theory of dynamic inefficiency in a competitive economy with intertemporal externalities arising from structural accumulation. Current output enhances future productive capacity, but firms fail to internalise this effect, generating a wedge between private and social returns to output. This missing intertemporal component of marginal returns is captured by a positive dynamic efficiency wedge. As a result, the competitive equilibrium is dynamically inefficient, with output systematically below the level consistent with intertemporal optimality.

The inefficiency arises under concave technologies and does not rely on increasing returns, non-convexities, or market power. The paper further shows that the optimal allocation can be decentralised through an output-contingent subsidy that internalises the dynamic efficiency wedge. The resulting policy is self-financing in present value while respecting a wage constraint, yielding an implementation that is both efficient and institutionally robust.

• Item Type: MPRA Paper
• Language: English
• Keywords: Dynamic inefficiency; Intertemporal externality; Structural accumulation; Dynamic efficiency wedge; Output determination
• Subjects: D - Microeconomics > D2 - Production and Organizations > D21 - Firm Behavior: Theory; D - Microeconomics > D2 - Production and Organizations > D24 - Production ; Cost ; Capital ; Capital, Total Factor, and Multifactor Productivity ; Capacity; D - Microeconomics > D6 - Welfare Economics > D62 - Externalities; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O41 - One, Two, and Multisector Growth Models

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