Consumption - Savings Decision Flashcards
What does consumption smoothing refer to?
The tendency of consumers to seek a consumption path over time that is smoother than income.
How is the desire for smooth consumption reflected?
It is reflected in the curvature of a consumer’s indifference curve.
What is the present value of disposable income?
Lifetime wealth.
Savings within this model are…
Postponed consumption - this money will be eventually consumed in the future.
When does the endowment point occur?
Occurs when consumption = disposable income, therefore savings are 0.
In a two-period model, government spending is financed through which 2 factors?
Taxes and issuing debt
What does The Ricardian equivalence theorem imply?
States the timing of taxes collected by the government is neutral, essentially, under specific conditions the timing of taxes is irrelevant.
A consumer is a borrower if…
The optimum current consumption is greater than current disposable income.
Explain the effects of increasing the interest rate within the Consumption/savings model?
An increased interest rate slightly pivots the budget constraint so that, current consumption declines - as the consumer increase their savings. However this model propels this concept of smooth consumption; meaning future consumption will then increase as a result. Altering the interest rate offsets both the substitution and income effect.
Define what is meant by the real interest rate?
The price you are willing to pay to transform one unit of future consumption into units of current consumption.
What are the effects of increasing a consumers’ disposable income; ceteris paribus?
Since in this model the Consumers preferences parallel the idea of smooth Consumption, the added income is consumed gradually throughout time, rather than spent in just one lump sum. As a result current consumption(C) Increases from C1 to C2, while also future Consumption(C’) increases from C’1 to C’2. The Consumer is also better off with an increase to their disposable income - meaning the indifference curve shifts outwards from I1 to I2.
