Consumption And Saving Flashcards by Toby Hill

National level of desired consumption

Is the aggregate quantity of goods and services that households optimally choose to consume, given income and other factors

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Desire national saving is the…

Level of aggregate saving when consumption is optimal

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Desire national saving=

Y - C - G

Income minus consumption - gov spending

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Budget constraint for current period

Future assets= income - consumption + assets

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Budget constraint in future period =

Future consumption = future income
+ (1+real interest rate)*futture asset

Cf= yf + (1+r)*af

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Saving =

Income - consumption

Y-C

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When saving what occurs…

Saving>0 as income>consumption and

future asset >0

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When dissaving

Consumption is greater than income

Saving <0

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The individual is a borrower if

Future asset < 0

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Individual is a lender if

future assets > 0

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When future assets > 0 then a person is a lender

What can saving be

S>0

S<0

S=0

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Is someone is a borrower then what is saving

Saving<0

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What is the trade off

Between current consumption and future consumption

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What determines the price of current and future consumption

Real interest rate

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Consolidated budget constraint

Combined the two period budget constraints

c + cf/1+r = y + a +yf/1+r

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What is the left hand side and the right side mean of the consolidated budget constraint

LHS = present value of lifetime consumption

RHS = present value of lifetime resources

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Inter temporal budget constraint properties

Cf = vertical axis

C = horizontal axis

Slope = -(1+r

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What happens to graph when interest rate is higher

Steeper budget constraint

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Household optimisation problem

Max U= u(c) + Bu(cf)

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What is B in the optimisation problem

Captures the extent to which consumers are patient -
If consumer is very impatient- she places less weight on future utility thus B is lower

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What is it when B = 1

Consumer treats utility received today and in future equally

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What is the optimality condition

u’(c) = B(1+r)u’(cf)

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What does optimality condition mean

Individual is indifferent between consuming one more item today or saving it and consuming it in the future

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When u’(c) > B(1+r)u’(cf)

Marginal utility of consumption today is higher than utility gained from consuming in the future

Thus consumer should increase current consumption

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FILL THIS CARD IN SLIDE 18

Is there is a low B what is consumption growth like

Growth is lower

What is consumption growth when high real interest rate

High consumption growth

consumption smoothing motive

Desire to have. Relatively even pattern of consumption

What does an increase in income do to PVLR and why

Raises PVLR because the consumption smoothing motive both current and future consumption are expected to increase

Marginal propensity to consume (MPC)

The fraction of additional current or future income that the individual allocates to current or future consumption Assume 0

Aggregate level

When aggregate output (Y) rises, aggregate consumption (C) rises but by less than Y so desired national saving also increases

What does temporary increase in income do…

Increase current income but future income is constant

Permanent increase in income…

Increase current and future income

Why does saving increase when income increases

Bc increase in consumption is less than the increase in income

What does increase in future income do to pvlr and consumption

Increase PVLR, consumption and future consumption

What does increase in future income do to savings and why

Decrease savings as current income is constant but consumption increases

What does an increase in real interest rate effec

Current consumption becomes more expensive so gives rise to substitution effect

Sub effect

Current consumption falls but savings and future consumption rises

Income effect for lender with respect to r

Increase in r = increased wealth thus an increase in c and cf but falls in savings

Income effect for borrower with respect to r

Rise in r = fall in wealth so fall in c and cf but rise in savings

Total effect of r on lender and borrower

Lender = unknown effect on savings - depends which effect is dominant Borrower = savings increase

How do we know if graph is a lenders graph

E0 is to the left of D

How do we know graph is borrowers graph

E0 is to the right of D

Expected real after tax interest rate =

(1-t)*i-expected inflation I = nominal interest rate

Assumption about fiscal policy

Does not affect Aggregate supply

Fiscal policy to do with

GOVERNMENT SPENDING AND TAXES

Disposable income =

Income - taxes

Change in disposable income affects what which then affects what

Disposable income effects consumption which then causes change in savings

National saving =

Sad= Y - Cd - G

Fall in $1 of national consumption does what to savings

Increase of $1 to nation savings

What increases to reduce national saving

Government spending

Two ways government can finance spending

Increasing taxes or borrowing

For financed by taxing what is change in G =

Change in taxes

What does increase in government spending do via tax

Increase taxing - so current disposable income decreases so current and future consumption decreases

Change in disposable income is =

- the change in taxes

Change in national consumption =

-MPC * change in G

Financing spending by borrowing does what to disposable income

Decrease future disposable income so future consumption also decreases

For borrowering what is change of government spending =

Change in future taxes q

What does a temporary increase in G do

Reduce aggregate consumption and aggregate saving

When government spending in creases = saving decreases But decrease consumption increases savings Which on dominates

Increase gov spending causing savings to decrease

Lump sum tax

Each tax payer pays the Same mount of tax

What does reducing tax do

Increase disposable income and increase consumption

For decreasing tax- what is the incrase in consumption done by

MC * change in disposable income

If governments does not increase spending and tax is reduced then gov must need to borrow- what happens then

Future taxes increase so future Yd decreases so current consumption falls by MPC * chnage in future disposable income

What is the effect on PVLR when gov keeps spending constant but reduces taxes

Increase current disposable income but decrease in future disposable income so PVLR is unknown as it depends which dominates

Ricardian equivalence proposition

Idea that tax cuts do not effect consumption and do not affect national saving - as if gov spending stays the same, a cut in taxes affects the time the tax is collected but no the ultimate burden of the tax

What increases PVLR more, permanent or temporary increase in income

Permanent