A variety-expansion model of growth with external habit formation

This paper introduces consumption externalities into one of the base line models of growth in which continuing expansion of product variety sustains long-term growth. We assume that consumers set a benchmark stock of consumption for each good so that there are commodity-specific external effects. Each good is produced by a monopolistically competitive firm and the firm exploits the presence of consumption external effects in determining its profit-maximizing price. Given those settings, we show that the introduction of consumption externalities may affect the balanced-growth characterization, transitional dynamics and policy effects in fundamental manners.