Consumption Externalities in a Ramsey Model with Endogenous Labor Supply

We consider a Ramsey model with heterogeneous agents and borrow- ing constraint. Heterogeneity across agents stems from di¤erent initial capital endowment, labor supply, felicity function and discount rate. For simplicity, heterogeneity is reduced to only two groups of agents where they are identical in each group. The felicity function of an agent de- pends on his own consumption as well as on others’ consumption. Our objective is to study the e¤ect of consumption externalities on economic stability around the steady state. As in standard models, only the pa- tient agents hold capital at the stationary equilibrium and further, this stationary equilibrium is not a¤ected by the presence of consumption ex- ternalities. There are two types of steady states: one with both agents labor supply and the other with only impatient agents supply labor while the patient agents enjoy leisure. Moreover, the interaction between exter- nalities and endogenous labor supply implies the emergence of endogenous fluctuations due to self-fulfilling expectations of agents.