MACROECONOMICS-CH16

Topic 13: Consumption (chapter 16) (revised 11/19/03)

Chapter overview ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Keynes’s Conjectures ,[object Object]

The Keynesian Consumption Function ,[object Object],C Y 1 c c = MPC = slope of the consumption function

The Keynesian Consumption Function As income rises, the APC falls (consumers save a bigger fraction of their income). C Y slope = APC

Early Empirical Successes: Results from Early Studies ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Problems for the Keynesian Consumption Function ,[object Object],[object Object],[object Object],[object Object],[object Object]

The Consumption Puzzle C Y Consumption function from long time series data (constant APC ) Consumption function from cross-sectional household data (falling APC )

Irving Fisher and Intertemporal Choice ,[object Object],[object Object],[object Object]

The basic two-period model ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Deriving the intertemporal budget constraint ,[object Object],[object Object],[object Object]

The intertemporal budget constraint present value of ______________ present value of _____________

[object Object],The intertemporal budget constraint C 1 C 2 Y 1 Y 2 _______ _____ Consump = income in both periods

[object Object],The intertemporal budget constraint C 1 C 2 Y 1 Y 2 1 (1+ r )

[object Object],Consumer preferences Higher indifference curves represent higher levels of happiness. Y Z X W C 1 C 2 IC 1 IC 2

[object Object],[object Object],Consumer preferences The slope of an indifference curve at any point equals the MRS at that point. So the MRS is the (negative) of the ___________________________. C 1 C 2 IC 1 1 MRS

[object Object],Optimization At the optimal point, __________ C 1 C 2 O

[object Object],How C responds to changes in Y Results: Provided they are both normal goods, C 1 and C 2 both increase, … _______________________________________________________. C 1 C 2

Temporary v. permanent Temporary rise in income: Y 1 alone Permanent rise in income: Y 1 and Y 2 equally S’ Y 2 Save part of income: So ________________. C moves with Y: So _________________. C 2 = C’ 1 C’ 2 C’ 2 = =‘C 1 =C 1 C 2 = =C 1 Y 1 Y 2 Y 1 Y’ 1 Y’ 2 Y’ 1

Keynes vs. Fisher ,[object Object],[object Object]

[object Object],How C responds to changes in r As depicted here, ______________ . However, it could turn out differently… A C 1 C 2 Y 1 Y 2 A B

How C responds to changes in r ,[object Object],[object Object],[object Object],[object Object]

Constraints on borrowing ,[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],Constraints on borrowing Y 1 Y 2 C 1 C 2 The budget line with a borrowing constraint

[object Object],Consumer optimization when the borrowing constraint is not binding Y 1 C 1 C 2

[object Object],[object Object],Consumer optimization when the borrowing constraint is binding Y 1 D E C 1 C 2

[object Object],[object Object],[object Object],Suppose increase in income in period 1 E Y’ 1 =C 1 ’ The rise in income to Y’ 1 shifts the budget constraint right. C’ 1 rises with Y’ 1. Y 1 =C 1 C 1 C 2

[object Object],[object Object],[object Object],[object Object],[object Object],The Life-Cycle Hypothesis

The Life-Cycle Hypothesis ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

The Life-Cycle Hypothesis ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Implications of the Life-Cycle Hypothesis ,[object Object],[object Object],[object Object],[object Object]

Implications of the Life-Cycle Hypothesis ,[object Object],Saving Dissaving Retirement begins End of life Consumption Income $ Wealth

Numerical Example ,[object Object],[object Object],[object Object],[object Object],[object Object]

Example continued ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

The Permanent Income Hypothesis ,[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],The Permanent Income Hypothesis

[object Object],[object Object],[object Object],[object Object],[object Object],The Permanent Income Hypothesis

PIH vs. LCH ,[object Object],[object Object],[object Object],[object Object]

The Random-Walk Hypothesis ,[object Object],[object Object],[object Object]

The Random-Walk Hypothesis ,[object Object],[object Object],[object Object],[object Object]

[object Object],Implication of the R-W Hypothesis

The Psychology of Instant Gratification ,[object Object],[object Object]

The Psychology of Instant Gratification ,[object Object],[object Object],[object Object]

Two Questions and Time Inconsistency ,[object Object],[object Object],[object Object],[object Object]

Summing up ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

MACROECONOMICS-CH16

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