204_summer_2009_lecture_2

204_summer_2009_lect - University of Toronto Department of Economics ECO 204 Summer 2009 Sayed Ajaz Hussain Lecture 2 Ajaz Hussain Department of

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University of Toronto Department of Economics ECO 204 Summer 2009 Sayed Ajaz Hussain Lecture 2 1 Ajaz Hussain. Department of Economics
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Today ± Economic models ± Modeling consumer preferences ² Preferences ² Rational, Convex, Monotone ² Representing preferences ² Interesting utility functions: ² Cobb Douglas utility function ² Linear utility function ² Quasi Linear utility function ² Complements utility function ² CES utility function 2 Ajaz Hussain. Department of Economics
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Economics as a Science ± Economics uses models to understand and investigate economic, social and human phenomena ± Models are deliberate abstractions of reality ± Model: ² Assumptions ² Mathematical or graphical representation/analysis ² Testable hypotheses ² Enrich model by relaxing assumptions Ajaz Hussain. Department of Economics 3
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A Simple Model ± In the General Theory of Employment, Interest and Money Keynes posited that: ² “ .. define . . propensity to consume as the functional relationship f between Y , a given level of income and C the expenditure on consumption out of that level of income, so that C = f ( Y )” ² “ .. that men are disposed, as a rule and on average, to increase their consumption as their income increases, but not by as much as the increase in their income” ² “ .. it is obvious that a higher absolute level of income will tend as a rule to widen the gap between income and consumption . . These reasons will lead, as a rule, to a greater proportion of income being saved as real income increases” ± Aside: Milton Friedman posited consumption is a function of lifetime income aka “permanent income hypothesis” ± Aside: Observe how Keynes and Friedman’s models are silent on intra period timing of consumption Ajaz Hussain. Department of Economics 4
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Keynesian Model of Consumption ± Let: C = Consumption, Y = Income ± MPC = dC / dY ² Marginal propensity to consume ± APC = C / Y ² Average propensity to consume ± Modeling Keynes: ² C increases with Y “. . but not by as much as the increase in their income” ² 0 < MPC < 1 ² “greater proportion of income being saved as real income increases” ² APC falls with income Ajaz Hussain. Department of Economics 5
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Keynesian Consumption Model ± C = f(Y) ± 0 < dC / dY < 1 ± d(APC) / dY < 0 ² d(C/Y) / dY < 0 ² [ Y(dC/dY) – C(dY/dY) ] / Y 2 < 0 [Do this] ² [ MPC – APC ] / Y < 0 ² MPC < APC ± We need model in which: ² C increases with Y, 0 < dC/dY < 1, and MPC < APC Ajaz Hussain. Department of Economics 6
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Keynesian Consumption Model ± Keynesian model of consumption: ² C = β 0 + β 1 Y [Review ECO 100 notes] ± MPC = dC/dY = β 1 ² Testable hypothesis ² 0 < β 1 < 1 ± APC = C/Y ² C/Y = β 0 /Y + β 1 ² APC = β 0 /Y + MPC ²
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This note was uploaded on 05/02/2011 for the course ECO 204 taught by Professor Hussein during the Fall '08 term at University of Toronto- Toronto.

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204_summer_2009_lect - University of Toronto Department of Economics ECO 204 Summer 2009 Sayed Ajaz Hussain Lecture 2 Ajaz Hussain Department of

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