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EC1B3 > Week 8: Consumption and Savings > Flashcards

Week 8: Consumption and Savings Flashcards

1
Q

Consumption and Savings Model - periods, income, taxes, consumers

A

2 periods - current and future
income - exogenous
lump sum taxes
consumers can be different

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2
Q

Current Period Equation

A

y-t = c+s

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3
Q

When is someone a lender?

A

savings > 0

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4
Q

When is someone a borrower?

A

savings < 0

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5
Q

Bond

A

A promise to pay in the future with 1 + r consumption good in exchange for 1 unit of consumption of the good today

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6
Q

Future period equation

A

c’ = y’ - t’ + (1+r)s

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7
Q

Lifetime Wealth

A

quantity of resources available to consumer in current consumption goods to spend on consumption goods over lifetime (2 periods)

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8
Q

Intertemporal Budget Constraint Definition

A

constraint faced by a decision maker who is making choices for both the present and future

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9
Q

Intertemporal Budget Constraint Equation

A

c + c’/(1+r) = y- t + (y’-t’/1+r)

C(1) + C(2)/(1+r) = Y(1) + Y(2)/(1+r)

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10
Q

Lifetime Wealth Equation

A

a = y + y’/(1+r) - t - t’/(1+r)

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11
Q

Lender and Borrower Diagram - Points X,Y,E

All labels

A
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12
Q

Optimal Choice of Lender Diagram

A
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13
Q

Optimal Choice of Borrower Diagram

A
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14
Q

Marginal Rate of Substitution (MRS)

A

the amount of a good that a consumer is willing to consume compared to another good, as long as the good is equally as satisfying

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15
Q

What happens as a result of an increase in current and future disposable income? (3 things)

A
  1. current and future consumption increases
  2. saving increases
  3. consumer acts to smooth consumption over time
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16
Q

Increase in current disposable income diagram

A
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17
Q

Increase in current disposable income equation

A
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18
Q

Increase in future disposable income diagram

A
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19
Q

Increase in Real Interest Rate for Lender Diagram

A
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20
Q

What happens to future consumption, current consumption and saving when interest rate rises for a lender?

A

c’ increases
c may increase or decrease
s may increase or decrease

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21
Q

What happens to future consumption, current consumption and saving when interest rate rises for a borrower?

A

c’ may increase or decrease
c decreases
s increases

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22
Q

Increase in real interest rate for borrower diagram

A
23
Q

Government Tax Revenue Equations in Each Period

A

First period = T =N(t)
Second period = T’ = N(t’)
N = constant population

24
Q

Government Budget Constraint First Period

A 
G = T + B
T = taxes 
B = debt
25
Q

Government Budget Constraint Second Period

A

G’ + (1+r)B = T’

26
Q

Government Intertemporal Budget Constraint

A

G + G’/(1+r) = T + T’/(1+r)

27
Q

What 3 things happen in competitive equilibrium?

A
  1. Consumers optimally choose current and future consumption given interest rates
  2. gov intertemporal budget constraint is satisfied
  3. credit market clears
28
Q

Credit Market Equilibrium Diagram

A
29
Q

Ricardian Equivalence Definition

A

economic theory that suggests that increasing government deficit spending will fail to stimulate demand as it is intended

30
Q

Endowment Point Definition

A

The initial allocation of the market

31
Q

Optimal Choice and Ricardian Equivalence Diagram

A

Diagram:

32
Q

Credit Market Equilibrium and Ricardian Equivalence

A
33
Q

When is Ricardian Equivalence not satisfied? (4 times)

A
  1. Tax changes are different for different consumers
  2. If someone dies in the first period
  3. if taxes are not lump sum
  4. If the credit market is not perfect , different interest rates for lenders and borrowers
34
Q

How to calculate the intertemporal budget constraint

A
  1. should have 2 budget constraints in the form consumption = incomes - savings
  2. combine the two and get intertemporal budget constraint
35
Q

PV of Consumption Equation

A

PV of consumption = financial wealth + human wealth

36
Q

What is the PV of labour income?

A

Human wealth

37
Q

Utility Definition

A

Total satisfaction received from consuming a good or service

38
Q

What does utility depend on?

A

Consumption today and in the future

39
Q

Utility Equation

A
40
Q

Diminishing Marginal Utility

A

the decrease in satisfaction a consumer has from consuming an extra unit of a good or service

41
Q

What does it mean if β < 1 in utility equation?

A
  • future consumption is discounted

- todays consumption is valued more than future consumption

42
Q

What does it mean if β = 1 in utility equation?

A

current and future consumption is treated equally

43
Q

How do you maximise utility subject to budget constraint?

A
44
Q

When is utility maximised?

A

When agents are indifferent between consuming more today or more tomorrow

45
Q

What choices do agents have when maximising utility?

A

Either:

  1. consume today
  2. consume 1+r units in the future
46
Q

Euler Equation

A
47
Q

What does the Euler equation show?

A

Marginal utility of consuming 1 more unit today = discounted marginal utility of consuming 1+r units in the future

48
Q

Marginal Utility

A

The added satisfaction a consumer gets from consuming one more unit of a good or service

49
Q

Method to Solve Euler Equation

A
  1. u(c) = log(c)
  2. derive u’(c) = 1/c
  3. Equation becomes 1/c(t) = β(1+r) 1/c(t+1)
  4. rearrange equation becomes c(t+1)/c(t) = β(1+r)
50
Q

What does the Euler equation explain?

A

explains how interest rates and growth rates are related

51
Q

What does a lower β in euler equation show?

A

impatient, consumption growth is lower

52
Q

What does a higher β in euler equation show?

A

patient, consumption growth is faster

53
Q

What do you need to solve for optimal consumption today and in the future?

A

Euler equation and intertemporal budget constraint

54
Q

Method to solve consumption for today and in the future if β = 1

A

EC1B3 (10 decks)

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