Revised Consumption

# Revised Consumption - Consumption Anthony Murphy Nuffield...

This preview shows pages 1–12. Sign up to view the full content.

Consumption Anthony Murphy Nuffield College [email protected]

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Outline Consumption – the biggest component of GDP/national expenditure; a good deal smoother than income . The two period model . Friedman’s permanent income hypothesis PIH - infinitely lived representative agent etc. Modligiani’s life cycle hypothesis LCH – finite life, saving for retirement, population dynamics. Hall’s consumption function – uncertainty, rational expectations and the consumption Euler equation . Euler equations versus (approx.) solved out consumption functions – pros and cons. Example of solved out consumption function for US.
Basic Two Period Model (1) Diagram: Axes - c 1’ y 1 on horizontal axis (the present) and c 2 ,y 2 on vertical axis (the future). Intertemporal preferences: Regular shaped indifference curves (as opposed to linear or L shaped ones). Less than perfect trade-off between c 1 and c 2 so want to smooth consumption over time. Intertemporal budget line : c 1 +c 2 /(1+r) = y 1 + y 2 /(1+r) (You can add an initial endowment a 0 (1+r) if you want to the RHS of the budget.)

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Consumption tomorrow 0 Indifference curves: Normal case Consumption today Fig. 6.02(a)
Consumption tomorrow 0 Indifference curves: Zero substitution Consumption today Fig. 6.02(b)

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Consumption tomorrow 0 Indifference curves: Constant substitution Consumption today Fig. 6.02(c)
Two Period Model (2) • Budget constraint is a straight line thru’ (y 1 ,y 2 ) point with slope equal to minus 1/(1+r). No borrowing or lending restrictions. Borrowing and lending rates are the same. Intertemporal budget constraint got by combining period 1 and period 2 budget constraints: c 1 + a 1 = y 1 c 2 = a 1 (1+r) + y 2

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Equilibrium in Two Period Model Equilibrium where highest attainable indifference curve is tangential to the budget line. • You may be a borrower (c 1 > y 1 ) or lender (c 1 < y 1 ) in period 1. First order condition (FOC): slope of indifference curve = slope of budget line ie. marginal rate of substitution (MRS) between c 1 and c 2 = 1/(1 + r).
Consumption tomorrow 0 Optimal consumption: borrower IC 1 IC 2 IC 3 B D R C 1 C 2 M Y 1 Y 2 (i) (i) Consumption today financed on credit (ii) (ii) Consumption loan repayment (including interest) Fig. 6.03 - (1+ r ) Consumption today

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Consumption tomorrow 0 Optimal consumption: lender A Y 1 Y 2 B IC 1 IC 2 IC 3 D R C 1 C 2 (i) (i) Saving from this period’s income (ii) (ii) Additional consumption next period Fig. 6.03 Consumption today - (1+ r )
FOC and Euler Equation* Suppose preferences are additive over time so U(c

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

## This note was uploaded on 10/16/2011 for the course ECONOMICS 620 taught by Professor Ziss during the Fall '11 term at Wilfred Laurier University .

### Page1 / 33

Revised Consumption - Consumption Anthony Murphy Nuffield...

This preview shows document pages 1 - 12. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online