Chapter 4 Flashcards
what is the consumption function? what 4 factors does it depend on? whats the most important one?
C = C(Y, Ye, r, A)
higher current income leads to increase in consumption
higher expected future labour income increases consumption
assume high real IR has negative effect on consumption
higher stock of assets increases consumption
what will a consumer do to smooth consumption over time?
only consume the real IR on a temporary increase in income
what does the marginal propensity to consume depend on?
whether the increase in income is perceieved as temporary or permanent,
degree to which consumers are credit rationed
what happens if real interest rate increases?
the substitution effect reduces current consumption if the consumer is net saver
income effect of higher interest income so net effect on current consumption and savings is ambiguous
what happens if p = real IR?
consumers will plan for a constant consumption over time
whats the sustainable level of consumption with a constant labour income and real IR?
Ct = Y^l + rAt
what do more impatient consumers do?
will consume more than their income so assets will decrease overtime
what is the natural rate of interest?
real IR that makes AD = Yn
makes desired savings = desired investment when production at Yn
what happens if real IR > natural rate? what do we see in the long run?
production below Yn, unemployment above
i = r - inflation
how much does private consumption make up of GDP? how does it behave?
50-70% GDP
about as volatile as GDP and highly correlated with it
two way causality
what is the lifetime budget constraint? what is it in a two period model?
says that the PV of lifetime consumption must = PV of lifetime income
C1 + C2/(1+r) = Y1^l + Y2^l / (1+r)
what does the consumers subjective rate of discount (p) show?
shows how consumption in the next period is valued compared with consumption today
how do you maximise lifetime utility?
consumption should be chosen so that MRS between consumption today and in next period = price of goods today relative to discounted prices of goods next year
u’ct/u’ct+1/ (1+p) = pt/pt+1/(1+it) = 1 +rt+1
