Week 4

Question 1

What does the consumption function show?

Answer 1

How consumption varies depending on the on the level of income

It is upward sloping because more income leads to more consumption

Question 2

What is the slope of the consumption function called?

Answer 2

The marginal propensity to consume

The slope describes the extra consumption that arises from each dollar of extra income

Question 3

How do you work out the slope / the marginal propensity to consume?

Answer 3

= change in consumption / change in income

Question 4

What does diminishing marginal benefit lead to?

Answer 4

A declining marginal benefit curve

Question 5

What does consumption smoothing require?

Answer 5

Redistributing spending from times of plenty to times of poverty

Times of plenty = high consumption with a low marginal benefit

Times of poverty = low consumption with high marginal benefit

Question 6

Why is consumption smoothing (redistributing spending from times of plenty to times of poverty) beneficial?

Answer 6

Because the marginal benefit of an extra dollar during times of poverty exceeds the marginal benefit of an extra dollar during times of plenty.

Question 7

Describe consumption over the lifecycle

Answer 7

When young, many consume more than their income (e.g. university students)

During work years, people save
In retirement, people draw down their savings

Question 8

What does the permanent income hypothesis state?

Answer 8

That our consumption is (should be) based on our total expected income over our lifetime, not out income today

Question 9

What does a temporary change in income lead to? (Permanent income hypothesis)

Answer 9

A small change in consumption

Question 10

What does a permanent change in income lead to? (Permanent income hypothesis)

Answer 10

A large increase in consumption

Question 11

What does an anticipated change in income lead to? (Permanent income hypothesis)

Answer 11

No change in consumption

Question 12

What does learning about a future income change lead to? (Permanent income hypothesis)

Answer 12

A change in consumption

Question 13

What can it be hard to do relating to consumption? (Permanent income hypothesis)

Answer 13

Difficult to forecast changes in consumption

Question 14

What do credit constraints mean? (Permanent income hypothesis)

Answer 14

Many people don’t have access to good borrowing products
E.g. low interest loans like a mortgage or car loan typically require collateral – this is only really available to people who have some wealth

Question 15

What does financial inclusion mean? (Permanent income hypothesis)

Answer 15

Many people don’t have access to good savings products
E.g. simple low cost bank accounts are not always available to migrants, rough sleepers, sex workers
Appropriate savings products are not always accessible to the elderly, people with learning disabilities, mental illness and addiction

Question 16

How does behaviour economics link to permanent income hypothesis?

Answer 16

It’s hard to make deliberate forward-looking plans and stick to them
e.g. the pensions opt-out system (where employees are included in workplace pensions by default and have to actively opt-out if they wish not to contribute) increases savings a lot because of the default inclusion option.

Question 17

What does a change in income lead to? (consumption function)

Answer 17

A change in income leads to a movement along the consumption function
–> Increase in income leads to a movement along the consumption function, leading to higher consumption

Question 18

What do changes in other factors do? (consumption function)

Answer 18

Shift the consumption function

Question 19

What do other factors that cause an increase in consumption at a given income level cause?

Answer 19

The consumption function to shift up