macro
Consumption
Topic 5
Topic 5
 Consumption
Consumption
slide 1
Chapter overview
Chapter overview
This chapter surveys the most prominent work
on consumption:
±
John Maynard Keynes:
consumption and
current income
±
Irving Fisher and Intertemporal Choice
±
Franco Modigliani:
the LifeCycle Hypothesis
±
Milton Friedman:
the Permanent Income
Hypothesis
±
Robert Hall:
the RandomWalk Hypothesis
±
David Laibson:
the pull of instant gratification
Topic 5
 Consumption
Consumption
slide 2
Keynes
’s Conjectures
s Conjectures
1.
0 <
MPC
< 1
2.
APC
falls as income rises
where
=
average propensity to consume
=
C
/
Y
3.
Income is the main determinant of
consumption.
Topic 5
Topic 5
 Consumption
Consumption
slide 3
The Keynesian Consumption Function
A consumption function with the
properties Keynes conjectured:
1
c
CCcY
=+
=
= slope of the
consumption
function
Topic 5
 Consumption
Consumption
slide 4
The Keynesian Consumption Function
The Keynesian Consumption Function
slope =
As income rises, the APC falls (consumers
save a bigger fraction of their income).
CC
YY
==+
Topic 5
Topic 5
 Consumption
Consumption
slide 5
Early Empirical Successes:
Early Empirical Successes:
Results from Early Studies
±
Households with higher incomes:
±
consume more
⇒
> 0
±
save more
⇒
< 1
±
save a larger fraction of their income
⇒
↓
as
↑
±
Very strong correlation between income and
consumption
⇒
income seemed to be the main
determinant of consumption
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentTopic 5
Topic 5
 Consumption
Consumption
slide 6
Problems for the
Keynesian Consumption Function
Keynesian Consumption Function
Based on the Keynesian consumption function,
economists predicted that
C
would grow more
slowly than
Y
over time.
This prediction did not come true:
±
As incomes grew, the APC did not fall,
and
grew just as fast.
±
Simon Kuznets showed that
/
was
very stable in long time series data.
Topic 5
Topic 5
 Consumption
Consumption
slide 7
The Consumption Puzzle
Consumption function
from long time series
data (constant
APC
)
Consumption function
from crosssectional
household data
(falling
)
Topic 5
 Consumption
Consumption
slide 8
Irving Fisher and Intertemporal Choice
Irving Fisher and Intertemporal Choice
±
The basis for much subsequent work on
consumption.
±
Assumes consumer is forwardlooking and
chooses consumption for the present and
future to maximize lifetime satisfaction.
±
Consumer’s choices are subject to an
intertemporal budget constraint
,
a measure of the total resources available
for present and future consumption
Topic 5
Topic 5
 Consumption
Consumption
slide 9
The basic two
The basic two
period model
period model
±
Period 1:
the present
±
Period 2:
the future
±
Notation
1
is income in period 1
2
is income in period 2
1
is consumption in period 1
2
is consumption in period 2
S
=
1
−
1
is saving in period 1
(
< 0 if the consumer borrows in period 1)
Topic 5
 Consumption
Consumption
slide 10
Deriving the
Deriving the
intertemporal budget constraint
±
Period 2 budget constraint:
22
(1
)
CY
rS
=+
+
21
1
) (
)
rY C
+
−
±
Rearrange to put
terms on one side
and
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '10
 MacoEconomics2
 APC

Click to edit the document details