On the Role of Externalities in the Choice of Technology

This paper examines technology adoption problems in a simple general equilibrium framework, characterized by the presence of a firm and a number of self-employed consumer. It is shown that the choice of technologies may be hindered, or even blocked when the firm is price maker on the labor market and price taker on the goods market. Two sources of externality are likely to determine inefficient technology choices and thus inefficiencies of market allocations. First, the firm's technology choice generates a positive externality on the production function of self employed workers. Second, this positive externality induces an increase in labor costs, hence implying a negative pecuniary externality on the firm. Pareto efficient allocations that would be generated by a social planner internalizing all sources of externalities are discussed, and different mechanisms of policy intervention in order to overcome (or mitigate) market failure are studied, ranging from non linear (first best) subsidization to Pigouvian (second best) subsidies/taxes on labor input and technology adoption.