1 / 25

A Two Period Model: Consumption-Savings Decision Ricardian Equivalence

2012/7/21. ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip. 2. Two-Period Model of the Economy. Focus on the consumer's and government's behavior.A consumer's consumption-savings decision (intertemporal choice) involves a trade-off between current and future consumption.By saving, a

badu
Download Presentation

A Two Period Model: Consumption-Savings Decision Ricardian Equivalence

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

    1. 2012/7/23 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 1 A Two Period Model: Consumption-Savings Decision & Ricardian Equivalence Chapter 8

    2. 2012/7/23 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 2 Two-Period Model of the Economy Focus on the consumers and governments behavior. A consumers consumption-savings decision (intertemporal choice) involves a trade-off between current and future consumption. By saving, a consumer gives up consumption in exchange for assets in the present, in order to consume more in the future. The governments decision concerning the financing of government expenditure, involves a trade-off between current and future taxes. Policy Implication: Ricardian equivalence theorem

    3. 2012/7/23 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 3 Consumers Assumptions: N consumers, where N is a large number Each consumer lives for two periods, current and future period. Each consumer receives exogenous income in both periods. Put aside the work-leisure decision. Income can differ across consumers. Zero wealth endowment (no assets) in the current period. Each consumer pays lump-sum taxes in both periods.

    4. 2012/7/23 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 4 Consumers Assumptions: Only bond is traded in financial market. Consumers can lend and borrow at the same real interest rate, r (Perfect credit market). No risk for holding bonds. Define bonds: A bond issued (by the government) in the current period is a promise to pay a certain amount, say 1 + r units, of consumption good in the future period. ? 1 unit of c can be exchanged for 1 + r units of c' in the credit market. r is the real interest rate on each bond.

    5. 2012/7/23 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 5 Consumers Notations: y and t denote real income and tax in first period. y' and t' denote real income and tax in second period. Current period budget constraint: c + s = y t (1) Consumers after-tax income can either be saved (s) or consumed (c). Saving > 0 (< 0) ? Buys (sells) a bond with part of his income. ? The consumer is a lender (borrower).

    6. 2012/7/23 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 6 Consumers Future period budget constraint: c' = y' t' + (1 + r)s (2) Apart from the after-tax income, the consumer receives the interest and principal on savings. For only two periods, no incentive to save in the second period. ? Consumer will consume everything he has in the second period. Next, to combine the two constraints into one lifetime budget constraint: From (2), we have

More Related