fflooki.blogg.se - Consumption economics

The effect of an interest rate change on consumption can be split up into a substituion effect from current consumption to future consumption, and into an income effect of higher future consumption on the basis of constant savings. Rising interest rates do however not only imply that future consumption rises at the expense of current consumption through savings. Specifically, consumption rises over time if the interest rate exceeds the discount rate and vice versa. If Friedman's model of consumption under certainty is expanded to account for interest rate changes, consumption doesn't necessarily follow a random walk. Changes in current consumption are furthermore determined by changes in expected lifetime income divided by the number of periods of life remaining. This implies that individuals adjust current consumption to the point where it is equal to expected future consumption. Robert Hall showed in his 1978 contribution to the Journal of Political Economy, "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis:Theory and Evidence., that consumption essentially follows a random walk if rational expectations are assumed. This contrasts with permanent income, which is concerned with an infinitely-lived individual, and is more focused on the short-term changes in consumption (but still assuming lifetime smoothing). The life cycle hypothesis considers a finitely-lived individual, and takes into account such factors as age, consumption, savings, and the accumulation of assets. The permanent income function implies that savings are essentially future consumption.ĭeveloped by Modigliani and Brumberg (1954, 1979), the life cycle hypothesis is similar to the Friedman's permanent income, though there are important, subtle differences. The only restriction is that all debt is repayed at the end of his or her life. In Friedman's model individuals are maximizing utility and can save and borrow at an exogenous interest rate. Temporary changes in income, transitory income, will therefore not have an effect on income unless they change permanent income significantly.

The part of income which is not saved (Macro definition)Ĭonsumption under Certainty - The Permanent Income Hypothesis The Permanent Income Hypothesis Īccording to the permanent income hypothesis as formulated by Milton Friedman an individual's consumption in a given period is not determined by income in that period, but by the individual's life time income and initial wealth, permanent income.

Consumption is the destruction of want satisfying capacity (Micro definition).

4 Responses to Changes in Interest Rate.

2 Consumption under Certainty - The Permanent Income Hypothesis.

Income retained for future spending is called saving, which also funds investment in the production of future consumer goods. Consumer spending typically only refers to spending on consumption in the present.

Consumers decide whether to spend their income now or in the future. Consumer spending is a major component of the demand side of " supply and demand" production of consumer goods is likewise an important piece of the supply side. This is because all goods that are consumed must first be produced.

Investors, businesses, and policymakers closely follow published statistics and reports on consumer spending in order to help forecast and plan investment and policy decisions.Ĭonsumption of final goods (i.e., not capital goods or investment assets) is the result of and ultimate motivation for economic activity.

Consumer spending is a key driving force in the economy and a critical concept in economic theory.

Consumer spending is all spending on final goods and services for current personal and household use.