consumption Flashcards
(23 cards)
neoclassical consumption model
Individuals choose consumption at each moment in time to maximize a lifetime utility function that depends on current and future consumption
People recognize that income in the future may differ from income today, and such differences influence consumption today.
first insight of the neoclassical consumption model
one can make a great deal of progress by thinking of time as involving only two periods: today and the future.
The consumption model is based on two main elements
an intertemporal budget constraint (IBC) and a utility function.
financial wealth
savings account balance and his holdings of stocks and bonds
2 budget constraints formulas
- y.today = c.today + (f.future - f.today)
- c.future = y.future + (1+R)f.future
IBC formula
c.today + (c.future/1 + R) = f.today + y.today + (y.future/1 + R)
human wealth
y.today + [y.future/(1 + R)]
diminishing marginal utility
each additional unit of consumption raises utility by a smaller and smaller amount.
utility function
U = u(c.today) + Bu(c.future)
B = how patient consumers are
B < 1
a given flow of utility is worth more when it occurs today
B = 1 utils received today and in the future are equal
Euler equation
uā(c.today) = B(1 + R)uā(c.future)
Log utility of euler equation
c.future/c.today = B(1 + R)
what does the euler equation explain
how interest rates and growth rates are linked
log utility for B = 1
c.today = 1/2 * X
c.future = 1/2 * (1 + R)X
effect on consumption caused by rise in IR
reduces present value, reducing consumption in the case of log utility (AKA wealth effect)
Permanent-income hypothesis (PIH)
consumption depends on some average value of income rather than on current income
intuition behind the PIH
consumers wish to smooth their consumption over time
(consider diminishing marginal utility)
marginal propensity to consumer (MPC)
proportion of a raise that is spent on the consumption of goods and services, as opposed to being saved
MPC is pretty small in this model (neoclassical)
Ricardian equivalence claim
a change in the timing of taxes does not affect consumption
Ex: a tax cut today, financed by an increase in taxes in the future, will not affect consumption if the Ricardian claim is true
key assumption of the neoclassical model
people can freely save of borrow at the market interest rate
random walk of consumption
changes in consumption should be unpredictable because all known information should be incorporated into current consumption
precautionary saving
when income is uncertain that consumers may save to hedge against the possibility of a large drop in income
this motive can lead to consumers behaving as if they face borrowing constraints
personal saving rate
the ratio of personal savinf to disposable income
