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Macroeconomic Analysis 2003. Consumption. 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. Consumption and GDP Fluctuate Together.

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slide1

Macroeconomic Analysis 2003

Consumption

Lecture 11

contents
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

slide6

Keynesian Absolute Income Hypothesis

APC declines with income

C

APC >MPC for low Y

APC  MPC for high Y

450

Y

Lecture 11

slide7

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

slide8

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

slide10

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

slide11

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

slide12

Micro-foundation Model of Consumption

Two Period Model of Consumption and Saving

C2

w2

c2

Borrowing

c1

w1

C1

Lecture 11

slide16

Consumption Choices with the Borrowing Constraints

Endowment and Consumption

point

w2

A

B

w1

Lecture 11

exercises
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