Lec7 - Finance 101: Monetary Economics &...

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Unformatted text preview: Finance 101: Monetary Economics & the Global Economy Lecture 7 Consumption and Savings II Prof. Hnatkovska Fall 2011 FNCE 101 - Hnatkovska - Lecture 7 2 Outline Interest rates and consumption Fiscal policy and consumption Ricardian equivalence 3 Readings ABC Chapter 4.1 ABC Appendix 4A 3 FNCE 101 - Hnatkovska - Lecture 7 Practice problems ABC chapter 4 Numerical question 8 4 FNCE 101 - Hnatkovska - Lecture 7 Nuanced PIH: Keynesian and PIH consumers Aesop's fable about grasshoppers and ants The ants are forward looking, like PIH theory suggests they know retirement or bad times are coming and prepare for it. Grasshoppers are Keynesian consume their current income and save very little Over 20% of households do not own a checking/saving account (over 50% of African American Households); (40% have less than $5k in liquid assets). FNCE 101 - Hnatkovska - Lecture 7 Nuanced PIH: Home Production We measure consumption expenditures, not consumption. When value of time is low (unemployment or retirement), individuals can take action to reduce their expenditure, but keep consumption unchanged: Clip coupons Search for bargains across stores Make your meal at home instead of buying it at a cafeteria. FNCE 101 - Hnatkovska - Lecture 7 FNCE 101 - Hnatkovska - Lecture 7 7 Review of consumption-smoothing model Consumers problem max c,cf {u(c) + *u(c f )} subject to c f = (a + y - c)(1+r) + y f max c {u(c) + *u[ ( a + y- c )(1+ r ) + y f ]} Solution Desired consumption: c* = c(y,y f ,a,r) Desired savings: s* = y c* = s(y,y f ,a,r) 7 MRS c u c u r MRT c u r c u f f = - = +- = = +- ) ( ) ( ) 1 ( ) ( ) 1 ( ) ( Effect of changes in interest rate So far we have focused at changes in income and wealth. Now lets analyze the effects of changes in prices....
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Lec7 - Finance 101: Monetary Economics &...

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