Externalities and nonlinear discounting: Indeterminacy
This paper studies a one-sector model with externalities and nonlinear discounting. Loosely, if the Bellman equation for a standard model is written as \(V(k)=\max\{u+\beta V(k')\}\), then the Bellman equation for our model is written as \(V(k)=\max{u+B(V(k'))}\) for some concave function \(B.\) Our model assumes that period utility (\(u)\) is linear in consumption and leisure and the production function exhibits increasing social returns and nonincreasing private returns. We establish the existence of a steady state under fairly general conditions and give a necessary and sufficient condition for local indeterminacy. We show that regardless of the degrees of increasing returns and externalities, there exists a discount function \(B\) such that indeterminacy arises. We also show that in a certain sense, as the degree of increasing returns converges to zero, the variability of discounting (the second derivative of \(B)\) required to generate indeterminacy also converges to zero. Numerical examples are provided. The main results are also extended to a one-sector model with fixed labor supply.
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