Public and private production in a two-sector economy

We develop a two-sector growth model in which there are conventional profit-maximizing private firms, together with “public firms”, whose objective is to produce a specified quantity of government investment goods - determined by government policy - at minimum cost. We characterize the equilibrium dynamics, and analyze a variety of fiscal disturbances, by simulating a calibrated economy. The effects of different policies, normalized in terms of their impact on the government's intertemporal deficit, are compared. We find that the effects of tax policies are robust with respect to the relative capital intensities of the two productive sectors. However, the effects of government investment are much more sensitive to this aspect.