Fiscal policy, distortionary taxation, and direct crowding out under monopolistic competition

A simple macroeconomic model with monopolistic competition on the goods market is developed which displays Keynesian features. The model is used to study the effects of a rise in public spending on national income. The model extends the literature in two directions. First, we assume that the government balances its budget by employing distortionary income taxation. Second, we allow for direct crowding out since public consumption enters private utility in a non-separable fashion. With upward sloping labour supply, an increase in public spending depresses national income, more so in the long run than in the short run.