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Unformatted text preview: 2. CONSUMPTION Suppose consumers have a utility function that depends on consumption, c , and the number of children in the household, K , i.e: J J D 1 1 ) , ( c K K c u a) Find an expression for the marginal utility of consumption, and show that it depends on the number of children in the household. Do you find this plausible? Explain. A researcher is investigating empirical models of consumption growth and estimates the following regression to explain the annual change in log consumption. He exploits a new dataset which asks people how they expect their income to change between this year and next year. The following estimates are obtained: Dependent variable: Change in log consumption Coeff. t-ratio Age 0.012 1.188 Change in number of children 0.277 5.280 Real interest rate 0.430 2.031 Expected change in log income 0.118 6.002 b) Interpret the coefficient on the real interest rate in the context of the utility function above. c) Consider the coefficient on the expected change in log income. Is this coefficient in accordance with the predictions of the Permanent Income Hypothesis? Explain your answer. In order to investigate this further the researcher creates a dummy variable, YOUNG, taking the value 1 if the individual is aged under 30 and runs the following model: Dependent variable: Change in log consumption Coeff. t-ratio YOUNG 0.020 0.812 Change in number of children 0.282 5.371 Real interest rate 0.420 2.132 Expected change in log income 0.022 1.424 Expected change in log income * YOUNG 0.603 8.923 d) Does the above model suggest that there is one particular group for whom the predictions of the Permanent Income Hypothesis do not hold? If so, identify this group and explain why might this be the case. e) Suppose, instead of using YOUNG, the researcher used a variable indicating whether the individual had any savings in the bank. Would this be sensible? Explain. 1 Consumption / Saving Question UCL: Econ 1002 Practical Lecture (March 2009) Matthew Wakefield (IFS / UCL) a) Find an expression for the marginal utility of consumption, and show that it depends on the number of children in the household. Do you find this plausible? Explain....
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