This paper employs a simple macroeconomic model of monopolistic competition to analyze the effects of fiscal policy when a fraction of government expenditure provides public services to private technology. This extension highlights a further transmission mechanism of fiscal policy, working through changes in marginal costs and prices. This additional effect implies that fiscal multipliers can exceed unity both in the short and in the long run. Moreover, once productivity is influenced by public investment the
conventional view that in the long run fiscal multiplier is independent from the degree of monopoly power does not hold anymore. Indeed, stronger market power depress the expansionary potential of fiscal policy since higher markups weaken the downward adjustment of prices resulting from lower marginal costs. Finally, an extensive welfare analysis is provided determining the optimal level of total public spending and the optimal composition between public investment and public consumption.