Investment externalities and a corrective subsidy

The paper proposes an intertemporal equilibrium model that highlights the i nterdependence between aggregate investment and the degree of product diffe rentiation with free entry of monopolistic producers. An investment externa lity is identified that results in underaccumulation of capital in the dece ntralized market equilibrium. Some form of investment promotion is called f or. The paper compares the effectiveness of a general investment tax credit and an ad valorem output subsidy with policies that favor smaller business size. It is also shown that the complementarity among individual investmen ts creates a potentially powerful investment multiplier.