Consumption Externalities and Pigouvian Ranking -- A Generalized Cobb-Douglas Example

This paper analyzes the impact of consumption externalities on the ``Pigouvian ranking,'' according to which the second-best level of public good provision is \emph{smaller} than the first-best level. Consumption externalities introduce exceptions to the Pigouvian ranking. Two necessary and sufficient conditions for reversal of the Pigouvian ranking are identified, when preferences for private goods (Cobb-Douglas) and the public good are weakly separable: (i) consumption generates a \emph{negative} externality, (ii) utility is not too concave in the subutility of private goods. If preferences are \emph{strongly} separable in the public good, the Pigouvian ranking is reversed if and only if the second-best consumption price is lower than the corrective (Pigouvian) consumption price.