Lec6 Cons Inv 2
Lec6 Cons Inv 2
Lec6 Cons Inv 2
Souvik Dutt a
CONSUMPTION
• Tinti n became a reporter today.
He is 20 years old.
• He plans to work until age 60 and
expects to die at age 80.
• He expects to earn 150 francs
every year he works (Y ).
• Spreading resources earned
during his service life ( S ) over the
remaining years of life (T ),
Tintin will spend
S ×Y
C = .
T
or 100 francs every
year.
Applicati on 1: m p c and nature of income
∆Y
∆C = .
T
• Therefore, mpc = ∆C
∆Y =T1
.
Applicati on 2: m p c and age distributi on
1. Borrowing constraints
2. Myopia
3. Precautionary savings
4. Bequest
• The theory assumes that when current desired consumption
is more than current income, an individual can borrow.
• But borrowing may not be an option for every individual
due to financial market frictions.
Deviations from L C H :
1. Borrowing constraints
2. Myopia
3. Precautionary savings
4. Bequest
• The theory assumes that when current desired consumption
is more than current income, an individual can borrow.
• But borrowing may not be an option for every individual
due to financial market frictions.
Deviations from L C H :
1. Borrowing constraints
2. Myopia
3. Precautionary savings
4. Bequest
• The theory assumes that individuals are able to correctly
value future consumption.
• But individuals could attach too much importance to the
present relative to the future.
Deviations from L C H :
1. Borrowing constraints
2. Myopia
3. Precautionary savings
4. Bequest
• The theory assumes that individuals save/dis-save only to
smooth consumption over the lifetime.
• But individuals could also save for future contingencies such
as unexpected healthcare expense.
Deviations from L C H :
1. Borrowing constraints
2. Myopia
3. Precautionary savings
4. Bequest
• The theory assumes that individuals only save for personal
consumption.
• But individuals could also save for consumption of future
generations.
Inter-temporal model
• Unti l now, we had simply assumed that individuals would
want to smooth consumption.
• Next, we consider a model where an individual optimally
chooses current and future levels of consumption.
• The key feature of this model is that consumer choice must
satisfy an inter-temporal budget constraint.
T h e basic two-period model
C 2 = Y 2 + (1 + r ) S
= Y 2 + (1 + r )(Y 1 − C 1 ).
• Re-arranging terms
(1 + r ) C 1 + C 2 = (1 + r)Y 1 + Y 2 .
Consump =
Saving
income in
both periods
Y2
Borrowin
g
F i g u r e 6: Inter-temporal
Y1 budget constraint
C1
Y1 Y 2 (1 r )
C2
The slope of
the budget
line equals 1
(1+r ) (1+r
)
Y2
C1
Y1
IC1
C1
F i g u r e 8: Consumer preference
C2 The slope of an
Marginal rate of indifference
substitution curve at any
(MRS ): the amount point equals the
of C2 MRS
the consumer 1 at that point.
would be willing to MRS
substitute for
one unit of C1.
IC1
C1
F i g u r e 9: Consumer preference
C2
The optimal (C1,C2)
At the optimal point,
is where the budget
MRS = 1+r
line
just touches
the highest
indifference curve. O
C1