macsg16 - 16 [31] Household and Firm Behavior in the...

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415 16 [31] Household and Firm Behavior in the Macroeconomy: A Further Look C hapter objectives: 1. State the reasoning behind the life-cycle hypothesis, explaining how it goes beyond Keynes’s theory of consumption. 2. Distinguish between the substitution effect and the income effect. Relate these effects to the factors affecting the decision to supply labor. 3. Outline the factors that affect the decisions to consume and to supply labor. 4. Outline the implications of employment constraints on the consumption and labor-supply decisions of households. 5. Describe the factors that influence the decisions of firms regarding employment and investment in plant and equipment. 6. Discuss the role of inventories in the output decision and describe the trade-off involved in reaching the optimal level of inventories. 7. Describe the relationship between the productivity of labor and the holding of excess labor by firms. 8. State Okun’s Law and list the “slippages” that make the “law” unstable. 9. Indicate how changes in each of the factors affecting the multiplier influence the size of the multiplier. BRAIN TEASER: Consider the following table, which shows labor-force participation rates for male workers in France, Germany, and the United States. Age France Germany United States 1967 2001 1967 2001 1967 2001 20–24 85.8 52.9 86.2 72.0 85.4 82.0 25–54 95.8 94.5 96.5 93.2 95.5 91.5 60–64 63.0 15.3 77.7 29.9 76.9 55.4
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416 Study Guide to Principles of Macroeconomics As you can see, the participation rates for prime-age males (those between 25 and 54) have varied only slightly across countries and over time. However, it is equally true that men are entering the labor force later and leaving it earlier, particularly in the European countries. Why? Can you think of government policies that might cause these variations across countries? OBJECTIVE 1: State the reasoning behind the life-cycle hypothesis, explaining how it goes beyond Keynes’s theory of consumption. Whereas Keynes argued that households base their consumption and saving decisions on current income, the life-cycle theory argues that current income is not the only determinant of consumption. Permanent income—i.e., current and expected future income—is important, as is wealth. The household’s long- range goal is to maintain a fairly stable level of consumption over the life cycle. It accomplishes this goal by dissaving in low-income periods of the life cycle (young and old) and accumulating a “nest egg” during the prime earning years. (page 297 [609]) The more permanent a change in income is perceived to be, the more consumption/saving behavior will adjust. Temporary “blips” in income will have little effect on consumption. If it is permanent income that affects consumption, we get a conclusion that, at first glance, seems unusual. If Jill’s income unexpectedly increases (she finds $100), the theory suggests that her consumption pattern will not change—she will save the money rather than spend it. (page 298 [600])
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macsg16 - 16 [31] Household and Firm Behavior in the...

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