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Comprehensive_Consumption_Theories_Presentation.pptx
- 1. Consumption Theories and Hypotheses Preparedfor Classroom Presentation
- 2. Keynesian Absolute IncomeHypothesis (AIH) • Proposed by John Maynard Keynes (1936). • Consumption depends primarily on current disposable income (Yd). • Consumption function: C = a + bYd, where a = autonomous, b = MPC. • Average propensity to consume (APC) decreases with income. • Saving increases as income rises.
- 3. 1. Keynesian AbsoluteIncome Hypothesis • Consumption depends mainly on current income. • MPC < 1: consumers spend a portion and save the rest. • APC falls as income rises (short-run behavior). • Policy implication: income boosts increase consumption and output.
- 4. 2. Relative IncomeHypothesis (Duesenberry) • Consumption depends on income relative to others (social comparison). • ‘Keeping up with the Joneses’ effect – people imitate consumption patterns. • Past peak income influences current consumption (‘ratchet effect’). • Explains stable long-run APC despite rising income.
- 5. 3. Fisher’s IntertemporalModel of Consumption • Consumers maximize lifetime utility subject to intertemporal budget constraint. • Choice between current and future consumption depends on interest rate (r). • Borrowing and saving smooth consumption over time. • Core equation: C1 + C2/(1+r) = Y1 + Y2/(1+r).
- 6. 4. Modigliani’s Life-CycleHypothesis • Consumption and saving depend on expected lifetime income, not just current income. • Individuals save during working years and dissave in retirement. • Consumption smoothing: goal is stable consumption throughout life. • Formula: C = aW + bY (W=wealth, Y=current income).
- 7. 5. Friedman’s PermanentIncome Hypothesis • Current income = Permanent + Transitory income (Y = Yp + Yt). • Consumption depends mainly on permanent income (C = aYp). • Temporary income changes lead to saving, not spending. • Explains why short-run APC fluctuates but long-run APC is stable.
- 8. Comparison Summary • Keynes:Consumption depends on current income. • Duesenberry: Relative income and habits matter. • Fisher: Consumers optimize across time with interest rate influence. • Modigliani: Life-stage planning drives consumption/saving behavior. • Friedman: Consumption reflects permanent, not temporary, income.
Editor's Notes
- #2 Keynes viewed consumption as linked to current income. Poor households spend most of their income, while richer ones save more. This model doesn’t include future expectations.
- #3 Explain that Keynes believed people consume based on what they currently earn, not future expectations. Use a simple upward-sloping C-Y diagram where the consumption line starts above origin (autonomous consumption).
- #4 Highlight how social norms and habits matter more than just income level. Show a figure comparing two families with different relative incomes but similar consumption patterns.
- #5 Discuss trade-offs between consuming today or tomorrow. Use a two-period diagram showing budget constraint and indifference curves intersecting at equilibrium.
- #6 Show a diagram with age on x-axis and income, consumption, and saving curves. Explain how people build up wealth mid-life and run it down later.
- #7 Use a figure showing Y (current) fluctuating around Yp (permanent). Emphasize smoothing behavior and how people respond differently to temporary income changes.
- #8 Summarize that all theories attempt to explain why consumption doesn’t move one-for-one with income, but differ in focus: current vs lifetime vs social vs permanent components.