Topic_5_-_Consumption - macro Chapter overview This chapter...

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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 Life-Cycle Hypothesis ± Milton Friedman: the Permanent Income Hypothesis ± Robert Hall: the Random-Walk 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
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Topic 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 cross-sectional 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 forward-looking 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
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Topic_5_-_Consumption - macro Chapter overview This chapter...

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