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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
Q

explain steps of increase in interest rate for Lender? [stronger Negative substitution effect]

A

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
Q

Draw the effect of increase in interest rate for Lender? [stronger negative substitution effect]

27
Q

explain steps of increase in interest rate for Lender? [stronger positive substitution effect]

A

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
Q

Draw the effect of increase in interest rate for Lender? [stronger positive substitution effect]

29
Q

Draw Intertemporal Choice for Borrower?

30
Q

explain steps of increase in interest rate for Borrower? [stronger positive substitution effect]

31
Q

Draw the effect of increase in interest rate for Borrower? [stronger positive substitution effect]

32
Q

explain steps of increase in interest rate for Borrower? [stronger negative substitution effect]

33
Q

Draw the effect of increase in interest rate for Borrower? [stronger positive substitution effect]

34
Q

OVERALL: Higher r for lender leads to ___ ___ …. c0 and ____ c1

A

depends on size of neg Sub and Pos W

both increase future consumption

35
Q

OVERALL: Higher r for borrower leads to ___ c0 and ____ ___ …. c1

A

both increase current consumption

depends on size of neg Sub and Pos W

36
Q

How does Life Cycle Hyp build on ITC? (x2) [what did ITC assume]

A

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
Q

What does Euler equation mean Consumers try to achieve?

A

Smooth Consumption

38
Q

x2 Assumptions for LCH

A

zero real interest rate [doesn’t affect outcome of model, only ^ savings]
consumption-smoothing is optimal

39
Q

LCH:
what does Lifetime resources = ?
C over entire period = ? [consumption func]

A

W + RY

C = aW + bY

40
Q

C = aW + bY

What does a and b mean? letters and explanation?

A 
a = [1/T] marginal propensity to consume out of wealth
b = [R/T] marginal propensity to consume out of income
41
Q

LCH SR implications x2

critisms x2

A
  1. monetary mechanism - wealth in consumption func
  2. transitionary income taxes
  3. uncertainty = saving rate higher for ppl without children bc they are independant [precautionary]
  4. Bequest motive - leave moeny for children to inherit
42
Q

LCH diagram

A

pg 492, sheet 5, slide36

43
Q

LCH solve the Consumption Puzzle

44
Q

PIH 2 types of income? Defs of each

A

Permanent; av Y expected to persist for lifetime

transitionary; temp deviations form average

45
Q

PIH Consumption Func

A

C = a x Yp [where a is fraction of permanent Y spent annually]

46
Q

APC is ____ for high Y households?

47
Q

What type of income does Consumption (Ct) respond more to?

Show this [remember Ct = F(Yt, Yt+1, rt)]

A

Permanent

Slide 39

48
Q

PIH vs LCH
x1 Difference for each
x32 similarities

A

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
Q

Random-Walk Hypothesis (by?)
Additional assumption & affect on C
so only____ ____ in W or Y that alter ____ ____ will change _____

A

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
Q 
Authors:
Intertemporal choice
Random - Walk Hyp
PIH
LCH
Consumption theory
A 
Authors:
Irving Fisher
Robert Hall
Friedman
Modigliani
Keynes
51
Q

EVAL of LCH & PIH

evidence of anticipated

A

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
Q

EVAL of PIH & LCH

evidence of unanticipated

A

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
Q

EVAL of Fisher’s ITC

A

If individuals are subject to borrowing constraints, then cannot alter current consumption (through borrowing/lending) thus they behave as Keynes theory suggests

54
Q

What is a non-binding borrowing constraint?

Where is optimal is constraint is binding

A

optimal c0 =< y0.

Corner point.

55
Q

Diagram for non-binding and binding budget constraint following an ^y0

56
Q

How does uncertainty affect future income?
What is the assumption?
What is expected future incomce equation?

A

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)= [pYgood t+1] + [(1-p)Ybad t+1]

57
Q

What is the Key Insight to understanding the effects of uncertainty?

A

in general, the function of the expected value is NOT EQUAL to the expected value of a function

58
Q

Draw precautionary savings due to Uncertainty [x4 steps]

Implications of this graph?

A
  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
Q

If uncertainty is increasing, what will happen in the good/bad income state?

A 
Good = even higher Ct
Bad = even lower Ct
60
Q

Does impirical evidence support Precautionary Savings model?

A

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
Q

Psychology of Instant Gratification
what do all theories so far assume?
survey found that 76% of ppl not ___ ____ for _____

A

Consumer rationally try max. lifetime utility.

Saving enough , retirement

62
Q

Why do ppl not save as much as they should?

A

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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