Chapter Three Consumption and Saving

1. Chapter ThreeConsumption and Saving 1. Consumption and saving analysis • Factors affect consumption current disposable income; foresight of income and price; interest rate for consumer’s credit; catch up with somebody; social security system; personal wealth

2. Factors affect saving precaution; foresight; interest rate; independence; enterprise; pride; avarice and miser

3. 2. Consumption Function • Definition The relationship between consumption and factors that affect consumption is described by the consumption function. • Especially we assume the that consumption increases with the level of disposable income: C = a + b Yd

4. Autonomous consumption variable a in C function ----represents the level of consumption when income is zero----the intercept on vertical axis of the C-curve • Induced Consumption be varied with income level---- the slope of the consumption curve and b Ydin C function

5. Propensity to consume Average propensity to consume (APC) APC = C/Yd -----is the proportion of consumption to income . Marginal propensity to consume (MPC) MPC = ∆C/∆Y ------ is the increase in consumption per unit increase in income. It is represented by variable b in C function.

6. 3. Short-run & long-run consumption curve • “Paradox of consumption function” • The shift of the Cs curve • Derivation of the CL-curve • Explain of the shift in the short-run curves

7. 4. Saving Function • Definition------Saving is equal to income minus consumption. • APS & MPS : MPC+MPS=1 ; APC+APS=1 • Saving curve • Saving function S = Yd - C = - a + (1-b) Yd

8. 5. Modern Consumption Theory • Absolute Income Theory • Relative Income Theory

9. Life-cycle Theory Some assumptions Basic function C = a WR + c YL where: a ---- MPC out of wealth WR ---- real wealth c ----- MPC out of labor income YL----- labor income

10. With lifetime consumption equal to lifetime income, we have C×NL = YL ×WL C = YL × WL/ NL Case: Numerical example Summarize: C is constant over the consumer`s lifetime and financed by lifetime income plus initial wealth.

11. During each year, a fraction,1/(NL - T), of wealth will be consumed, where (NL - T) is the life expectancy. Current consumption spending depends on current wealth and lifetime income.

12. Permanent income theory A) The form of the theory: C = c YP YP----- permanent disposable income c------ is the MPC B) Estimating of the YP: YP = Y-1 +θ(Y - Y-1) =θY+(1-θ)Y-1 C) Permanent Income and Consumption C = cYP = cθY + c(1-θ)Y-1