Chapter9 - Chapter 9 Preference Shocks We have derived the...

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© Sanjay K. Chugh 115 Spring 2008 Chapter 9 Preference Shocks We have derived the consumption demand curve and the labor supply curve in the context of the consumption-leisure model. Specifically, by varying either the wage or the price of consumption (and holding the other constant), we traced out a single labor supply and consumption demand function. However, much of macroeconomic fluctuations are attributed to shifts, not movements along, the aggregate demand function, which in turn can be attributed to shifts of the consumption demand function. We need to consider now why this function might shift. The most natural explanation of such shifts is that consumer tastes change over time, perhaps due to evolving cultural norms or society- wide unexpected events. 54 Given our study of consumer theory, we have a ready way of modeling such changes in consumer preferences, namely by supposing that an individual’s utility function changes occasionally – that is, the utility function is subject to periodic shocks. We will briefly consider one way of introducing this feature into our theoretical model and see that it does indeed induce shifts in the consumption demand function (and thus by extension the aggregate demand function). A Utility Function Augmented by Shocks Recall our usual one-period consumption-leisure model. We now slightly modify the utility function in that model to be (, ) uBcl , (1.12) in which B is some given constant over which the individual has no control. The constant B
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Chapter9 - Chapter 9 Preference Shocks We have derived the...

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