Optimal Consumption of Polluting and Non-Polluting Goods: The Role of Habits
27 Pages Posted: 6 Jan 2016 Last revised: 10 Jun 2016
Date Written: January 5, 2016
We present a basic exogenous growth model with two consumption goods that differ as regards their contributions to environmental pollution. Allowing for habit formation of the polluting good, we show under which conditions habit formation raises the consumption of the clean good relative to the dirty one in the competitive economy. Further, we demonstrate when habit formation generates a lower steady-state pollution stock compared to the situation without habits. Finally, we determine the Pigou tax rates and we illustrate that the social optimum may imply a higher steady-state pollution than the competitive economy if the habit formation is sufficiently strong.
Keywords: environmental pollution, clean and dirty consumption, habits, optimal control
JEL Classification: Q50, H23, C61
Suggested Citation: Suggested Citation