In this paper, we combine a standard overlapping generations model with aspirations and environmental quality in the utility function. The combination of both externalities (environmental degradation and aspirations) generates a steady-state capital stock that can be higher or lower than in the standard Diamond Economy. The study focuses next on the analysis of the optimal allocation and its decentralization by means of an appropriate tax policy. A sufficiently high social discount factor is necessary in order to avoid possible local oscillations.
Moreover, investment should either be subsidized or taxed depending on the magnitude of both externalities while maintenance investment should always be subsidized.
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