Class notes
notes
- Course
- Institution
- Book
Lecture notes study book Basic Economics of Thomas Sowell (1) - ISBN: 9780465060733, Edition: 5th edition, Year of publication: -
[Show more]
Connected book
Book Title:
Author(s):
- Edition:
- ISBN:
- Edition:
More summaries for
-
Economía IB HL diagrams
-
Resumen temario economia IB
Seller
Follow
lollol6
Content preview
EC201 Intermediate MacroeconomicsEC201 Intermediate Macroeconomics
Lecture 33-34: Consumption
Lecture Outline:
- Keynesian consumption function and the “consumption puzzle”;
- Fisher’s two period model of consumption;
- Life Cycle and Permanent Income theory of consumption;
- Consumption as a random walk;
Essential reading:
Mankiw: Ch. 17
Keynesian Consumption Function
When we discussed the Keynesian Cross model and the IS-LM model we did
introduce the Keynesian Consumption Function:
C t = C 0 + cYt 1)
The main features of that function are:
a) the only determinant of current aggregate consumption is current income;
b) the Marginal Propensity to Consume (MPC) is 0 < c < 1 ;
Ct C0
c) the Average Propensity to Consume (APC) = + c is decreasing with
Yt Yt
income;
The properties a), b) and c) are called the Keynes Conjectures.
Property b) means that only a part of current income is consumed and so a proportion
1 − c becomes saving.
Property c) says that as income increases (meaning consumers become richer)
consumers will save a larger fraction of income.
Graphically the Keynes Consumption function looks like:
1
, C
C=C0+cY
MPC
C0
slope=APC
Y
The slope of any ray connecting zero with a point on the consumption function is the
Average Propensity to Consume. As income increases a ray connecting zero with a
point on the production function becomes flatter meaning that the slope is decreasing.
Why the slope those rays is the APC? Consider the point C1 ,Y1 on the consumption
function. Take a ray starting from zero and passing through the point C1 ,Y1 . Then you
have a triangle (a right triangle). From basic trigonometry the slope of the ray is then
the opposite side ( C1 ) divided by the adjacent side ( Y1 ).
C
C=C0+cY
C1
slope=C1/Y1
Y1 Y
Now we can ask: Is the Keynesian Consumption function a good representation of
consumers’ behaviour?
This is an empirical question. By looking at early empirical evidence (in the 30s and
40s) we had:
2
, 1) Cross-sectional evidence: this was evidence coming from surveys about
households at a given point of time. For example a sample of 1000 consumers
in 1934. The results from this evidence were:
a) Richer households consumed more than poorer ones ⇒ MPC > 0
b) Richer households saved more than poorer ones ⇒ MPC < 1.
c) Richer households saved larger fractions of their income ⇒ APC ↓ asY ↑.
d). The correlation between current income and current consumption was
found to be very strong (this was found during the Great Depression).
Therefore according to this evidence it seemed that the Keynesian
Consumption Function was a good representation of consumers’ behaviour.
2) Time series evidence: in 40s new pieces of evidence about aggregate
consumptions were found by Simon Kuznets (a Nobel prize winner). He
created a set of data from the US national accounts from 1869 to the 1940s on
aggregate Y and C. According to the Keynes Consumption Function aggregate
consumption should grow more slowly than income. This is because as Y
increases, C also increases but proportionately less than income. Moreover as
income increases APC should decrease. Kuznets found that the ratio C/Y was
very stable in long time series data. This implies that C grew at the same rate
as income and as income increased APC did not fall.
Therefore we have two different pieces of evidence giving very different results.
The difference between the two was that the first one was cross-sectional in detail
(they looked at a snapshot of the economy at a point) whereas Kuznet’s study was of a
time series nature (it looked at the economy over many points in time). So the
evidence seemed to indicate that there were two consumption functions: a short-run
consumption function which seemed to conform to Keynes’s conjectures and a long-
run consumption function in which the APC was basically constant. This is known as
the Consumption Puzzle.
We can see how this looks with the following graph:
3
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller lollol6. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $10.70. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
53022 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now