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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 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
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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
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 Spring '10
 MacoEconomics2

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