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Macroeconomics Sem1 > Consumption > Flashcards

Consumption Flashcards

1
Q

Keynes 3 Conjectures

A
  1. 0
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2
Q

Keynes Consumption Func GRAPH

  • Slope & Intercept
  • Show APC falls for ^Y
A

Look up pg1

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3
Q

Problems with Keysian C Func.

A

APC did not fall, C and Y grew at same rate.
Keynes predicted that Savings rate would increase, but just stayed stable
Keynes model is static [accounts for single period]

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4
Q

Intertemporal Chocie:

  • Assumes consumer choose ____ & ___ ____to ____ ____ ___
  • Consumers are subject to ____ ____ ____
A

Current, future consumption, max Lifetime utility/satisfac

Intertemporal budget constraint

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5
Q

Def Intertemporal Budget Constraint

A

total resources available for current and future C

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6
Q

What does ITC take as Exogenous?

A

Income - assumed to be Y1 and Y0

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7
Q

Do you save in future period? Why?

A

no only in current as only considered to be 2 periods. no consumption in t1 - assumed to be dead

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8
Q

(ITC) Real Budget Constraint at Time 0 & 1

Sub together and Rearrange for S0
What does S0 represent?

A

C0 + S0 = Y0
C1 = Y1 + (1 + r) S0

Real Savings

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9
Q

If s>0?

If s<0?

A

Lender

Borrower [need to repay in future so interest neg]

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10
Q 
Lifetime Budget Constraint
Y =
W = 
Written as a line equation (slope &amp; intercept)
Written meanings for each term [W=]
A 
Y= C0 + (C1 - Y1) / (1 + r)
from [ C0 + S0 = Y ]
W = [ (c0+c1)/(1+r) ] = [ (y+y1)/(1+r) ]
c1= -(1+r)c0 + (1+r)W
Wealth = PV lifetime C = PV lifetime Y
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11
Q

What does endowment mean?

A

The level of y0 to consume c0, y1 and c1.

exogenous income at time 0 & 1

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12
Q

3 assumptions of consumer preferences?

A
  1. more is better
  2. preference for diversity [eg 10 now and 10 in future]
  3. consumption today and tomorrow are normal goods [^y = ^d]
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13
Q

Slope of I.D curve = …

what does ID curve show?

A

MRSc0,c1 [marginal rate of intertemporal substiution]

Shows rate at which c1 is subbed for c0

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14
Q

Lifetime Utility formula

What does Beta equal and what is its value?

A

Slide 16

Consumers level of impatience, Beta < 1

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15
Q

Change in Lifetime utility formula

What does Beta equal?

A

slide 16 - requires derivation of c0 & c1

Consumers level of impatience, Beta < 1

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16
Q

What does change in U equal on same indifference curve?

A

= 0, because there is no change in utility on the same ID, only a change in preferences between c0 & c1

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17
Q

Write the change in lifetime utility formula in terms of MRSc0,c1
Think what MRSc0,c1 means

A

slide 16

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18
Q

At the optimal point, what about the gradient? Values?

A

(1+r) = MRSc0,c1

Budget constraint grad = ID grad

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19
Q

At t0, on the x axis of borrower …

What is repayment equal to?

A

c0 > y0

y1 - c1 +r

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20
Q

What is lagragian func used for?

What is the structure of Lag func?

A

Combines the function being optimized with functions describing the constraint or constraints into a single equation. Solving the Lagrangian function allows you to optimize the variable you choose, subject to the constraints you can’t change.

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21
Q

What are we maximising in Euler Eq? In terms of letters?
What is constraint in Euler? Letters? (think of max _____ ____ st. _____ ______)
What is Langrian of set up for Euler?

A

Slide 20

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22
Q

What are the steps for calc Euler Eq? [6

What is Euler in terms of (1+r) [=MRS]?

A
  1. set up lang func.
  2. FOC for Ct and Ct+1
  3. Make =0 (at max.)
  4. Rearrange for Lambda
  5. Make them equal each other & rearrange for Ct+1
  6. Sub this back into budget constraint
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23
Q

What happens to budget line when r increases?
Why? (x2 view points)
Always pivots around? Why?

A

Line becomes steeper [Remem: ^rate is pretty steep]
Savers: c1 becomes relatively cheaper, more interest earnt on savings so Wealth increases to W2
Borrowers: pay more for current period c0, so fall in W1
Endowment Point -lender/borrower must always be able to consume y0 &y1

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24
Q

Draw Intertemporal Choice for Lender?

A

Slide 25, sheet 4

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25
explain steps of increase in interest rate for Lender? [stronger Negative substitution effect]
Point A to C same ID curve and imaginary BC that is tangental to C and parallel to final BC=Neg sub, Posi Wealth Effect Point C to B, BC and ID Curve shift out due to higher Ct+1 = [new BC intersects Endowment point] KEY POINT: decrease in c0 from wealth effect is greater than increase in c0 from sub effect [net fall in c0]
26
Draw the effect of increase in interest rate for Lender? [stronger negative substitution effect]
slide26
27
explain steps of increase in interest rate for Lender? [stronger positive substitution effect]
Point A to C same ID curve and imaginary BC that is tangental to C and parallel to final BC=Neg sub, Posi Wealth Effect Point C to B, BC and ID Curve shift out due to higher Ct+1 = [new BC intersects Endowment point] KEY POINT: decrease in c0 from sub effect is less than increase in c0 from wealth effect [net rise in c0]
28
Draw the effect of increase in interest rate for Lender? [stronger positive substitution effect]
slide 27
29
Draw Intertemporal Choice for Borrower?
slide 29
30
explain steps of increase in interest rate for Borrower? [stronger positive substitution effect]
slide 30
31
Draw the effect of increase in interest rate for Borrower? [stronger positive substitution effect]
slide 30
32
explain steps of increase in interest rate for Borrower? [stronger negative substitution effect]
slide 30
33
Draw the effect of increase in interest rate for Borrower? [stronger positive substitution effect]
slide 31
34
OVERALL: Higher r for lender leads to ___ ___ .... c0 and ____ c1
depends on size of neg Sub and Pos W | both increase future consumption
35
OVERALL: Higher r for borrower leads to ___ c0 and ____ ___ .... c1
both increase current consumption | depends on size of neg Sub and Pos W
36
How does Life Cycle Hyp build on ITC? (x2) [what did ITC assume]
Both dynamic models but LCH says that income varies systematically over consumers life cycle, and that saving allows for consumer to achieve smooth consumption unlike ITC which assumed Consumer Lifetime income exogenous
37
What does Euler equation mean Consumers try to achieve?
Smooth Consumption
38
x2 Assumptions for LCH
zero real interest rate [doesn't affect outcome of model, only ^ savings] consumption-smoothing is optimal
39
LCH: what does Lifetime resources = ? C over entire period = ? [consumption func]
W + RY C = aW + bY
40
C = aW + bY | What does a and b mean? letters and explanation?
``` a = [1/T] marginal propensity to consume out of wealth b = [R/T] marginal propensity to consume out of income ```
41
LCH SR implications x2 | critisms x2
1. monetary mechanism - wealth in consumption func 2. transitionary income taxes 1. uncertainty = saving rate higher for ppl without children bc they are independant [precautionary] 2. Bequest motive - leave moeny for children to inherit
42
LCH diagram
pg 492, sheet 5, slide36
43
LCH solve the Consumption Puzzle
slide 35
44
PIH 2 types of income? Defs of each
Permanent; av Y expected to persist for lifetime | transitionary; temp deviations form average
45
PIH Consumption Func
C = a x Yp [where a is fraction of permanent Y spent annually]
46
APC is ____ for high Y households?
lower
47
What type of income does Consumption (Ct) respond more to? | Show this [remember Ct = F(Yt, Yt+1, rt)]
Permanent Slide 39
48
PIH vs LCH x1 Difference for each x32 similarities
LCH current income changes systematically (with life cycle) PIH current income is subject to random, transitionary fluctuations BOTH: -ppl try achieve smooth C, with changing Y0 -can explain consumption puzzle -dynamic, 2 period models
49
Random-Walk Hypothesis (by?) Additional assumption & affect on C so only____ ____ in W or Y that alter ____ ____ will change _____
Robert Hall rational expectations; ppl use all available info to forecast future variables like income ie. if change in Y or W anticipated, then will be factored in unanticipated changes, permanent income, consumption
50
``` Authors: Intertemporal choice Random - Walk Hyp PIH LCH Consumption theory ```
``` Authors: Irving Fisher Robert Hall Friedman Modigliani Keynes ```
51
EVAL of LCH & PIH | evidence of anticipated
WICOX: ^social security benefits, C not adjusted before, only after SHAPIRO & SLEMROD: fall in tax withholding, no change in C until after policy implemented
52
EVAL of PIH & LCH | evidence of unanticipated
PRESTON: C reaction to permanent shocks much higher than transitionary Studied the unanticipated change in rainfall and how this affects consumption, through the production function
53
EVAL of Fisher's ITC
If individuals are subject to borrowing constraints, then cannot alter current consumption (through borrowing/lending) thus they behave as Keynes theory suggests
54
What is a non-binding borrowing constraint? | Where is optimal is constraint is binding
optimal c0 =< y0. | Corner point.
55
Diagram for non-binding and binding budget constraint following an ^y0
slide 51
56
How does uncertainty affect future income? What is the assumption? What is expected future incomce equation?
higher precautionary savings there are only 2 states of future income [good & bad] and there probability of occuring are p & (1-p) E(Yt+1)= [p*Ygood t+1] + [(1-p)*Ybad t+1]
57
What is the Key Insight to understanding the effects of uncertainty?
in general, the function of the expected value is NOT EQUAL to the expected value of a function
58
Draw precautionary savings due to Uncertainty [x4 steps] | Implications of this graph?
1. Draw ID and label Good and Bad States 2. Label expected utility in the middle (point E) 3. Connect the Good and Bad states (with straight line) 4. Mid-point gives expected future Marginal utility of Ct+1 because of uncertainty.
59
If uncertainty is increasing, what will happen in the good/bad income state?
``` Good = even higher Ct Bad = even lower Ct ```
60
Does impirical evidence support Precautionary Savings model?
YES - increase in savings and fall in consumption = 40% of savings due to precautionary motive. Estimate that 2% of household net worth is precaution savings
61
Psychology of Instant Gratification what do all theories so far assume? survey found that 76% of ppl not ___ ____ for _____
Consumer rationally try max. lifetime utility. | Saving enough , retirement
62
Why do ppl not save as much as they should?
In SR, ppl are impatient - want instant gratification | LR, more patient, but this decreases as time falls

Macroeconomics Sem1 (7 decks)

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