Information about Intertemporal Consumption
Economic theories of intertemporal consumption seek to explain people's preferences in relation to consumption and saving over the course of their life. The earliest work on the subject was by Irving Fisher and Roy Harrod who described 'hump saving', hypothesizing that savings would be highest in the middle years of a person's life as they saved for retirement.
In the 1950s more well-defined models built on discounted utility theory and approached the question of intertemporal consumption as a lifetime income optimization problem. Solving this problem mathematically, assuming that individuals are rational and have access to complete markets, Modigliani & Brumberg (1954), Albert Ando, and Milton Friedman (1957) developed what became known as the life-cycle model. This model predicts that people consume an annuity of their expected lifetime income at all points in their life. Thus, the lifetime consumption profile was expected to be essentially flat, with people borrowing against future earnings during their early study and working life when income is low, saving greatly during their most productive working years and consuming saved assets during retirement. Windfall gains would be treated the same way as an unexpected increase in income - its lifetime annuity value would be consumed and the rest saved.
Attempts to test the life-cycle model against real world data have met with mixed success. In a review of the literature, Courant, Gramlich and Laitner (1984) note "but for all its elegance and rationality, the life-cycle model has not tested out very well." The main discrepancies between predicted and actual behaviour is that people drastically 'underconsume' early and late in their lifetime by failing to borrow against future earnings and not saving enough to adequately finance retirement incomes respectively. People also seem to 'overconsume' during their highest earning years, the elderly do not consume from their assets as would be expected (particularly from their household equity) and also treat windfall gains in a manner inconsistent with the life-cycle model. Specific alterations to the theory have been proposed to help it accommodate the data; a bequest motive, capital market imperfections such as liquidity constraints, a changing individual utility function over time or a particular form of expectation as to future income.
Behavioural economists have proposed an alternate description of intertemporal consumption, the behavioural life cycle hypothesis. They propose that people mentally divide their assets into non-fungible mental accounts - current income, current assets (savings) and future income. The marginal propensity to consume (MPC) out of each of these accounts is different. Drawing upon empirical studies of consumption, superannuation and windfall gains they hypothesize that the MPC is close to one out of current income, close to zero for future income and somewhere in between with respect to current assets. These differing MPCs explain why people 'overconsume' during their highest earning years, why increasing superannuation contributions does not cause current savings to be reduced (as the life-cycle model implies) and why small windfall gains (which are coded as current income) are consumed at a high rate but a higher proportion of larger gains is saved.
In economics, consumption refers to the final use of goods and services to provide utility.
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The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time.
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In the 1950s more well-defined models built on discounted utility theory and approached the question of intertemporal consumption as a lifetime income optimization problem. Solving this problem mathematically, assuming that individuals are rational and have access to complete markets, Modigliani & Brumberg (1954), Albert Ando, and Milton Friedman (1957) developed what became known as the life-cycle model. This model predicts that people consume an annuity of their expected lifetime income at all points in their life. Thus, the lifetime consumption profile was expected to be essentially flat, with people borrowing against future earnings during their early study and working life when income is low, saving greatly during their most productive working years and consuming saved assets during retirement. Windfall gains would be treated the same way as an unexpected increase in income - its lifetime annuity value would be consumed and the rest saved.
Attempts to test the life-cycle model against real world data have met with mixed success. In a review of the literature, Courant, Gramlich and Laitner (1984) note "but for all its elegance and rationality, the life-cycle model has not tested out very well." The main discrepancies between predicted and actual behaviour is that people drastically 'underconsume' early and late in their lifetime by failing to borrow against future earnings and not saving enough to adequately finance retirement incomes respectively. People also seem to 'overconsume' during their highest earning years, the elderly do not consume from their assets as would be expected (particularly from their household equity) and also treat windfall gains in a manner inconsistent with the life-cycle model. Specific alterations to the theory have been proposed to help it accommodate the data; a bequest motive, capital market imperfections such as liquidity constraints, a changing individual utility function over time or a particular form of expectation as to future income.
Behavioural economists have proposed an alternate description of intertemporal consumption, the behavioural life cycle hypothesis. They propose that people mentally divide their assets into non-fungible mental accounts - current income, current assets (savings) and future income. The marginal propensity to consume (MPC) out of each of these accounts is different. Drawing upon empirical studies of consumption, superannuation and windfall gains they hypothesize that the MPC is close to one out of current income, close to zero for future income and somewhere in between with respect to current assets. These differing MPCs explain why people 'overconsume' during their highest earning years, why increasing superannuation contributions does not cause current savings to be reduced (as the life-cycle model implies) and why small windfall gains (which are coded as current income) are consumed at a high rate but a higher proportion of larger gains is saved.
See also
- Albert Ando
- José-Victor Ríos-Rull
- Wealth elasticity of demand
- Permanent income hypothesis
References
- Fisher, I (1930): The Theory of Interest
- Harrod, R. (1948): Towards a Dynamic Economics
- Friedman, M. (1957): A Theory of the Consumption Function
- Modigliani, F. & Brumberg, R. (1954): 'Utility analysis and the consumption function: An interpretation of cross-section data'. In: Kurihara, K.K (ed.): Post-Keynesian Economics
- Shefrin, H. & Thaler, R. (1992): 'Mental Accounting, Saving and Self-Control'. In: Lowenstein, G. & Elster, J. (eds.) Choice over Time
Preference (or "taste") is a concept, used in the social sciences, particularly economics. It assumes a real or imagined "choice" between alternatives and the possibility of rank ordering of these alternatives, based on happiness, satisfaction, gratification, enjoyment, utility
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- For other uses, see consumption
In economics, consumption refers to the final use of goods and services to provide utility.
Keynesian economics and aggregate consumption
In Keynesian economics aggregate consumption..... Click the link for more information.
In common usage, saving generally means putting money aside, for example, by putting money in the bank or investing in a pension plan.
In a broader sense, saving is typically used to refer to economizing, cutting costs, or to rescuing someone or something.
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In a broader sense, saving is typically used to refer to economizing, cutting costs, or to rescuing someone or something.
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Irving Fisher (February 27 1867 Saugerties, New York – April 29 1947, New York) was an American economist, health campaigner, and eugenicist, and one of the earliest American neoclassical economists and, although he was perhaps the first celebrity economist, his reputation
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Sir Roy Forbes Harrod (1900-1978) was an English economist, who Independently of Evsey Domar developed an important economic model called the Harrod-Domar model.
Born in Norfolk, Harrod attended New College in Oxford.
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Born in Norfolk, Harrod attended New College in Oxford.
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Discounted utility is an economics term in which economists, accountants, underwriters, and other financial analysts include the future discounted value of a good into its present value. This can be thought of as valuing goods with low depreciation more than disposable goods.
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Franco Modigliani
Born May 18 1918
Rome
Died September 25 2003 (aged 85)
Cambridge, Massachusetts
Residence U.S.
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Born May 18 1918
Rome
Died September 25 2003 (aged 85)
Cambridge, Massachusetts
Residence U.S.
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Milton Friedman
Born July 31 1912
Brooklyn, New York City
Died November 16 2006 (aged 94)
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Born July 31 1912
Brooklyn, New York City
Died November 16 2006 (aged 94)
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For other uses, see Annuity.
The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time.
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A windfall gain is any type of income that is unexpected.[1]
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Types of Windfall Gains
The list of windfall gains includes, but is not limited to:- Lottery winnings
- Unexpected inheritance
- Gains from demutualization
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A bequest motive seeks to provide an economic justification for the phenomenon of gratuitous, intergenerational transfers of wealth. In other words, to explain why people leave money behind when they die.
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A liquidity constraint in economic theory is a form of imperfection in the capital market. It causes difficulties for models based on intertemporal consumption.
Many economic models require individuals to save or borrow money from time to time.
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Many economic models require individuals to save or borrow money from time to time.
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In economics, utility is a measure of the relative satisfaction or desiredness from consumption of goods. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain economic behavior in terms of attempts to increase one's utility.
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Behavioral finance and behavioral economics are closely related fields which apply scientific research on human and social cognitive and emotional biases to better understand economic decisions and how they affect market prices, returns and the allocation of resources.
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A concept first named by Richard Thaler (1980), mental accounting attempts to describe the process whereby people code, categorise and evaluate economic outcomes. Mental accounting theorists argue that people group their assets into a number of non-fungible mental accounts.
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The marginal propensity to consume (MPC) refers to the increase in personal consumer spending (consumption) that occurs with an increase in disposable income (income after taxes and transfers).
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worldwide view of the subject.
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For the lodging, see .
A pension is a steady income given to a person (usually after retirement)...... Click the link for more information.
Wealth elasticity of demand in microeconomics is the relation of the proportional change in consumption of a good to a proportional change in wealth (as distinct from changes in personal income).
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The permanent income hypothesis (PIH) was developed by the American economist Milton Friedman. In its simplest form, PIH states that the choices made by consumers regarding their consumption patterns are determined not by current income but by their longer-term income expectations.
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