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Unformatted text preview: Macroeconomics Theory and Policy Masoud Anjomshoa 1 Masoud Anjomshoa 1 Consumption Theory Chapter 20 Masoud Anjomshoa 2 Consumption is a very crucial part of demand, because: Consumption: 1 the only objective of an economy is producing the maximum possible consumption, because people’s welfare is only depending on their consumption. 2 Consumption is the biggest part of GDP, so the shocks to consumption and consumption its movements have the biggest impact on the total economy (GDP). 3 The size of Marginal Propensity to Consume (MPC) is very important for effectiveness of the government fiscal policies. Macroeconomics Theory and Policy Masoud Anjomshoa 2 Masoud Anjomshoa 3 1 Marginal Propensity Keynes Consumption Theory: . 2 Average Propensity to Consume (APC) C Y d c o MPC=c 1 MPC=c 1 0 < MPC < 1 Secular Stagnation Hypothesis: As income increases, saving goes up faster than consumption, so demand for goods does not rise adequately, then there would be a long depression. Masoud Anjomshoa 4 Keynes Consumption Theory: . C Y d c o APC 0 < MPC < 1 Early empirical studies based on time series of households confirmed the Keynes assumptions. MPC = constant Macroeconomics Theory and Policy Masoud Anjomshoa 3 Masoud Anjomshoa 5 Keynes Consumption Theory: . C Y d c o APC 0 < MPC < 1 MPC = constant 3 As opposed to classical view that believed higher interest rate leads to lower consumption, Keynes believed in short run practically consumption is not correlated to interest rate. Masoud Anjomshoa 6 Two Period Model: Current Real Income: Y 1 , Future Real income: Y 2 , Lending/Borrowing Real Interest Rate: r Future Current (1+r) Y 1 E Y 2 r 1 Y Y r 1 C C 2 1 2 1 + + = + + Y 1 = C 1 + S Y 2 + (1+r)S = C 2 C 2 =Y 2 + (1+r)(Y 1 – C 1 ) r 1 Y Y 2 1 + + ( ) 1 2 Y r 1 Y + + Macroeconomics Theory and Policy Masoud Anjomshoa 4 Masoud Anjomshoa 7 r 1 Y Y r 1 C C . t . s 2 1 2 1 + + = + + Two Period Model: Current Real Income: Y 1 , Future Real income: Y 2 , Lending/Borrowing Real Interest Rate: r Future Current(1+r) Y 1 E Y 2 r 1 Y Y 2 1 + + ( ) 1 2 Y r 1 Y + + U O ( ) 2 1 C , C U Max C 1 C 2 U’ U” Masoud Anjomshoa 8 r 1 Y Y r 1 C C . t . s 2 1 2 1 + + = + + Two Period Model: Current Real Income: Y 1 , Future Real income: Y 2 , Lending/Borrowing Real Interest Rate: r Future Current(1+r) C 1 O C 2 r 1 Y Y 2 1 + + ( ) 1 2 Y r 1 Y + + U E Y 1 Y 2 S=B ( ) 2 1 C , C U Max U’ U” Macroeconomics Theory and Policy Masoud Anjomshoa 5 Masoud Anjomshoa 9 Two Period Model:...
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 Spring '08
 ANJOMSHOA
 Macroeconomics, Consumption function, Permanent income hypothesis, Masoud Anjomshoa

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