Lec6 - Finance 101: Monetary Economics & the Global Economy...

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Finance 101: Monetary Economics & the Global Economy Lecture 6 Consumption and Savings Prof. Hnatkovska Fall 2011
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FNCE 101 - Hnatkovska - Lecture 6 2 Outline What drives household consumption? The intertemporal consumption-smoothing model The Permanent Income Theory Consumption under borrowing constraints Does consumption theory line up with the data? What is the link between consumption and savings?
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3 Readings ABC chapter 4.1 ABC Appendix 4A FNCE 101 - Hnatkovska - Lecture 6
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Practice problems ABC chapter 4 Review questions 2 Numerical questions 1 4 FNCE 101 - Hnatkovska - Lecture 6
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Consumption Major component of spending (70% of GDP). Includes purchase of goods and services by individuals. Two reasons why studying consumption is important: It is the largest component of demand for goods and services; Deciding how much to consume is linked to how much to save. Cd = desired consumption; Sd = desired saving. Assume all income is disposable, Yd = Y (NFP=0, transfers=0) Then Sd = Y- Cd - G FNCE 101 - Hnatkovska - Lecture 6
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Households savings in China FNCE 101 - Hnatkovska - Lecture 6
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Household Savings in the U.S. 1959-02-01 1962-10-01 1966-06-01 1970-02-01 1973-10-01 1977-06-01 1981-02-01 1984-10-01 1988-06-01 1992-02-01 1995-10-01 1999-06-01 2003-02-01 2006-10-01 2010-06-01 0 2 4 6 8 10 12 14 16 share of disposable income FNCE 101 - Hnatkovska - Lecture 6
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Old-school consumption? Keynesian Consumers (named after a theory of John Maynard Keynes): C = a + b*Yd (ignoring Taxes and Transfers: Yd = Y) a = ‘subsistence’ level of Consumption b = marginal propensity to consume = MPC Key: Consumption is based solely on current income. Based on cross-country and long-run time series data: a ~ 0 and MPC = ΔC/ ΔY ~ 0.90 Problem: In Micro Data (household data) over short term, MPC << 0.90 Run a regression: ΔC = β0 + β1 ΔY + error (using household data), usually find β1 around 0.40! The Keynesian consumption function does not seem to match short-run (household) data. It does match long-run (country level) data. FNCE 101 - Hnatkovska - Lecture 6
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Consumption theories Other drawbacks to Keynesian Consumption Functions: Does not Result from Optimizing Household Behavior Does not Allow for the Role of Interest Rates Does not Distinguish Between Different Types of Income (one-time increase vs. permanent increase) Does not allow for uncertainty (no expectations) Is there another theory which allows us to look at household Consumption Behaviour? Intertemporal Choice (Fisher) Lifecycle (Modigliani) Permanent Income Hypothesis (Friedman) FNCE 101 - Hnatkovska - Lecture 6
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10 Intertemporal consumption model The consumption and saving decision of an individual Assumes consumer is forward-looking and chooses consumption for the present and future to maximize lifetime satisfaction. Trade-off between current consumption and future consumption
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This note was uploaded on 10/26/2011 for the course ASDF 2342 taught by Professor 2adga during the Spring '11 term at Mansfield University of Pennsylvania.

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Lec6 - Finance 101: Monetary Economics & the Global Economy...

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