Dynamic Interactions among Growth, Environmental Change, Habit Formation, and Preference Change

Abstract

The purpose of this study is to construct an economic growth model with environmental change and preference formation. The paper is focused on dynamic interactions among capital accumulation, environmental change, habit formation, preference change, and division of labor in perfectly competitive markets with environmental taxes on production, wealth income, wage income and consumption. The model integrated the dynamic economic mechanisms in the neoclassical growth theory, the environmental dynamics in traditional models of environmental economics, and the literature of economic growth with habit formation and within a comprehensive framework. It is showed that the motion of the economic system is given by three nonlinear autonomous differential equations. We simulate the time-invariant system. The simulation demonstrates some dynamic interactions among the economic variables which can be predicted neither by the neoclassical growth theory nor by the traditional economic models of environmental change. For instance, if the past consumption has weaker impact on the current consumption, although the long-term equilibrium of the dynamic system will not be affected, the transitional paths are shifted as follows: initially the transitional path of the stock habit becomes lower than its original path; the consumption level falls initially in association with falling in the propensity to consume; the exogenous disturbance causes the propensity to consume to fall and the propensity to save to rise; the national wealth and capital inputs of the two sectors are augmented; the labor force is shifted initially from the industrial sector to the environmental sector, but subsequently the direction is opposite before the labor distribution comes to its original equilibrium point; the wage rate is enhanced in association with falling in the rate of interest; the level of pollution falls initially, but rise subsequently; the output levels of the two sectors and the total tax income are enhanced before they come back to their original paths.
Classification-JEL: H12
Keywords: Habit formation; preference change; environmental tax; pollution; economic growth.