lecture5 - 1 5-1 Consumption, Saving, and Investment, Part...

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Unformatted text preview: 1 5-1 Consumption, Saving, and Investment, Part 1 5-2 Agenda Consumption and Saving Determinants of National Saving Investment 5-3 Consumption and Saving Consumption and saving decisions : Desired consumption is the consumption amount desired by households Desired national saving is the level of national saving when consumption is at its desired level: S d = Y C d G 5-4 Consumption and Saving Consumption and saving decisions: A person can consume less than current income, i.e., saving is positive. A person can consume more than current income, i.e., saving is negative. 2 5-5 Consumption and Saving Consumption and saving decisions: There is a trade-off between current and future consumption: The price of 1 unit of current consumption is 1 + r units of future consumption, where r is the real interest rate. Consumption-smoothing motive : the desire to have a relatively even pattern of consumption over time. 5-6 Consumption and Saving Effect of changes in current income : Increases in current income increase both consumption and saving. Because the marginal propensity to consume the fraction of additional income consumedis less than 1. When current income ( Y ) rises, C d rises, but not by as much as Y , so S d also rises. 5-7 Consumption and Saving Effect of changes in expected future income : Higher expected future income raises current consumption even at the same current income level, so current saving declines. 5-8 Consumption and Saving Effect of changes in wealth : Increase in wealth raises current consumption even at the same current income level, so current saving declines. 3 5-9 Consumption and Saving Effect of changes in the real interest rate : A higher real interest rate has 2 effects. The Substitution effect on saving is positive because a higher rate of return is a greater reward for saving. The Income effect on saving is mixed: It is negative for a net saver because it takes less saving to achieve a given amount in the future (target saving). It is positive for a net borrower because a higher real interest rate represents a loss of wealth. 5-10 Consumption and Saving Effect of changes in the real interest rate : Taxes and the real return to saving. The expected after-tax real interest rate is given by: r a-t = (1 t ) i e 5-11 Consumption and Saving Effect of changes in fiscal policy : Changes in fiscal policy affects desired consumption through changes in both current and expected future income. They directly affect desired national saving: S d = Y C d G 5-12 Consumption and Saving Effect of changes in fiscal policy : Government purchases : Higher G financed by higher current taxes reduces after- tax income, lowering desired consumption....
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This note was uploaded on 04/01/2008 for the course ECON 100B taught by Professor Wood during the Spring '08 term at University of California, Berkeley.

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lecture5 - 1 5-1 Consumption, Saving, and Investment, Part...

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