Life Cycle Theory of Consumption

Life Cycle Theory of Consumption - Life Cycle Theory of...

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Life Cycle Theory of Consumption R e t i r e D i e C o n s u m p t i o n T i m e D i s s a v i n g s S a v i n g s C M a x i m u m W e a l t h Franco Modigliani’s Life Cycle Theory of Consumption is based on the simple idea that people would prefer to even out consumption over their lifetime rather than have some periods where they are flush with cash and other periods where they are starving in the streets. The graph above takes this idea to the extreme and keeps the level of consumption (at C bar) the same over your lifetime. During the years you are working, you save money. When you retire, you live off your savings until you die. The day you die the amount of money you have left is zero. It is easy to make this model more realistic by including the fact that money earns interest, that people have wealth from sources other than labor income, and that people want to leave money to the kids. In reality some of the more difficult
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