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Question 1

Consumption

Answer 1

expenditure on goods and services by private individuals
–> biggest expenditure component of GDP (50-70%)

Question 2

Consumption and GDP volatility

Answer 2

Consumption follows GDP but is less volatile than GDP (moves less over time)

Question 3

Idea of Basic Keynesian Model of Consumption

Answer 3

people consume their income and they consume more as their income increases
–> but not as much as the increase in income

Question 4

Household perspective on consumption and savings

Answer 4

either you consume your income or you save it

C/Y = 1 - S/Y

Question 5

Why is the Marginal Propensity to Consume (MPC) so important?

Answer 5

Keynes’ idea: changes in demand determine economic flucuations

Question 6

National Accounts identity

Answer 6

Output = Consumption + Government Expenditure + Investment

Y = C + G+ I
insert C
Y = (A+G+I) / (1-c)

Question 7

Consumption function

Answer 7

C = A + (c*Y)

Question 8

Keynesian Multiplier

Answer 8

1/1-c > 1

due to impact effect and multiplier effect

Question 9

Keynesian Multiplier - Intuition

Answer 9

• an increase in government consumption raises aggregate demand and production
• firms increase hiring and wages and thus income increases
• people use some of the extra income to consume
• an increase in consumption raises aggregate demand and production
• firms increase hiring and wages and thus income increases

Question 10

Permanent Income Model

Answer 10

• Individuals make complex plans throughout their lives
• they form expectations about the future
• they aim to forecast the lifetime pattern of their income and they plan consumption accordingly
• individuals are going to consume very different fractions of their current income

Question 11

Implications of the Permanent Income Model

Answer 11

Consumption varies less than income today, because changes are distributed over periods
- it will not fall as much in recessions
- it will not rise as much in booms
- consumption smoothing

A temporary increase in income has a lower impact on consumption today than a permanent increase
- additional income will be used to increase consumption a little bit in each period
- crucial wenn thinking about fiscal policy
- temporary increase gives a low MPC –> low multiplier

Expectations about future income can change consumption today

Savings can be lower if individuals expect their income to grow

Question 12

Caveats of the Permanent Income Model

Answer 12

People have the ability to anticipate their future income ( and uncertainty –> higher savings) => lower multiplier

people must be able to borrow
–> if they can’t: borrowing constraints –> lower C today => large multiplier

Question 13

Lifetime budget constraint

Answer 13

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