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Macroeconomic Analysis 2003

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Presentation on theme: "Macroeconomic Analysis 2003"— Presentation transcript:

1 Macroeconomic Analysis 2003
Consumption Lecture 11

2 Contents Importance of Consumer Confidence
Co-movement of Consumption and GDP Five Main Theories of Consumption Reconciliation of Absolute and Permanent Hypothesis Calculation of Life Cycle Income Lecture 11

3 Consumption and GDP Fluctuate Together
Lecture 11

4 Lecture 11

5 Theories of consumption
Lecture 11

6 Keynesian Absolute Income Hypothesis
APC declines with income C APC >MPC for low Y APC  MPC for high Y 450 Y Lecture 11

7 Permanent Income Hypothesis of Consumption
APC is constant in the long run C Consumption relates to permanent Saving or borrowing for transitory Y YP or W Lecture 11

8 Reconciliation Between Keynesian and Kuznet’s Hypothesis
LCF SCF3 C SCF2 SCF1 SCF1-SCF3 are short run consumption functions, and LCF is the long run consumption function. APC varies with income in the short run but it is constant in the long run. Y Lecture 11

9 How can short run APC vary but long run APC be constant?
Lecture 11

10 Life Cycle Model of Consumption and Saving
Modigiani-Ando-Brumberg life cycle hypothesis Saving C,S,Y C-Smoothing Borrowing Dissaving Old Young Adult Lecture 11 Smooth consumption and erratic income over life

11 Random Walk Theory of Consumption
Sometimes people consume more than the trend . . . . . . +ve . Shock or noise C . . . . . . -ve . Sometimes people consume less than the trend Life Lecture 11

12 Micro-foundation Model of Consumption
Two Period Model of Consumption and Saving C2 w2 c2 Borrowing c1 w1 C1 Lecture 11

13 First Order Conditions of Optimisation
Lecture 11

14 Main Results of the Two Period Model of Consumption
Lecture 11

15 Optimal Saving and Consumption in Two Period Model
Lecture 11

16 Consumption Choices with the Borrowing Constraints
Endowment and Consumption point w2 A B w1 Lecture 11

17 MPC Out of Transient and Permanent Income
Lecture 11

18 How to Calculate Life Cycle Consumption?
Lecture 11

19 Example of Life Cycle Income and Consumption
Individuals Initial income Tax rate Growth Factor Working life consumption life Life time Income consumption A 1,000,000 0.4 1.03 36 56 39,704,534 709,010 B 50,000 0.3 1.04 2,859,579 51,064 C 40,000 0.25 20 860,295 15,362 D 0.2 30 1,898,507 33,902 E 20,000 0.15 40 60 1,337,276 22,288 F 10,000 0.1 1.05 65 1,150,558 17,701 Lecture 11

20 Exercises Role of consumer confidence in the economy
Absolute income, permanent income and Life cycle income hypothesis Intertemporal model of consumption Consumption smoothing and saving for retirement problems Impact of income tax on consumption Consumption under borrowing constraint Life cycle income-consumption and saving scenarios Lecture 11


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