1) Ricardian equivalence observes that a cut in current taxation financed by future tax increases has the same present value as tax cuts financed by government bonds. It argues this means tax cuts will not affect short-run or long-run consumption.
2) The document uses household savings functions to show that if a tax cut is financed by bonds, household savings will increase by the full amount of the new bonds, so consumption remains unchanged.
3) It discusses how liquidity constraints can impact household consumption decisions. A binding liquidity constraint means a household cannot borrow and must consume all current income, leaving them worse off than with no constraint.
The life cycle income hypothesis asserts that consumers save and consume based on their optimal consumption pattern over their lifetime, subject to resource constraints. It emphasizes saving during working years to fund consumption in retirement years when income is lower. The hypothesis divides a person's life into three stages - childhood, middle age, and old age - with consumption gradually rising and income peaking in middle age then declining in retirement, resulting in dissaving early and late in life and saving in middle years.
The document summarizes the relative income hypothesis proposed by Dusenberry in 1949. The key points are:
1) Dusenberry argued that consumption depends more on a person's relative income position compared to others in their community, rather than their absolute income level. People will consume more if they live in wealthier communities to maintain their standard of living.
2) In the short run, the average propensity to consume is greater than the marginal propensity to consume and the relationship between income and consumption is not proportional. In the long run, consumption increases proportionally with income and the average propensity to consume equals the marginal propensity to consume.
3) Dusenberry also believed consumption
Keynes proposed that as income increases, consumption increases but not as much as the rise in income, meaning the marginal propensity to consume is less than one. The relationship between consumption and income can be expressed as C=A+BY, where C is consumption, A is autonomous consumption, B is the marginal propensity to consume, and Y is real disposable income. When total income in a community increases, consumption spending also increases but to a lesser degree, so increased income is split between consumption and savings.
In Macroeconomics Income and Employment are interchangeable terms, since in the short-run National income depends on the total volume of employment or economic activity in the country. As income and employment are synonymous the employment theory is also called income theory.
It should be clear to readers that the classical economists did not formulate any specific theory of employment as such. They only laid down certain postulates which subsequently developed as a theory.
Domar's growth model from 1946 analyzes how a capitalist economy can grow at a constant rate after reaching full employment. It assumes aggregate supply equals aggregate demand during steady growth. The model shows that for steady growth, the rates of investment, capital stock growth, output growth, and employment growth must all be equal. It derives the equation that the growth rate equals the savings ratio multiplied by the incremental output-capital ratio. Investment has dual effects of increasing both aggregate demand and productive capacity in the long-run.
Consumption function shows the relationship between consumption and income. Keynes proposed the psychological law of consumption, which states that as income rises, consumption increases but by less than the rise in income. Consumption depends on both subjective psychological factors and objective external factors. The average propensity to consume is the ratio of consumption to income, while the marginal propensity to consume is the change in consumption from a change in income.
The neoclassical theory of interest, or loanable funds theory, holds that the interest rate is determined by the supply and demand for loanable funds. The demand for loanable funds comes from investment, consumption/dissaving, and hoarding. The supply comes from savings, bank credit, dishoarding, and disinvestment. The interest rate reaches equilibrium when the total demand for loanable funds equals the total supply. Critics argue the theory assumes full employment, does not precisely determine the interest rate, and is impractical.
Milton Friedman's monetarist theory of inflation argues that inflation is always caused by increases in the money supply. When the money supply increases, people's real cash balances exceed demand, so they spend more on goods and services, bidding up prices if output does not rise. The rate of inflation is determined by the rate of growth of the money supply minus the rate of output growth, with inflation directly related to money supply increases when the economy is at full employment. Friedman's theory modifies Keynes' ideas and assumes full employment, but critics argue it ignores fiscal policy and speculative demand for money.
The life cycle income hypothesis asserts that consumers save and consume based on their optimal consumption pattern over their lifetime, subject to resource constraints. It emphasizes saving during working years to fund consumption in retirement years when income is lower. The hypothesis divides a person's life into three stages - childhood, middle age, and old age - with consumption gradually rising and income peaking in middle age then declining in retirement, resulting in dissaving early and late in life and saving in middle years.
The document summarizes the relative income hypothesis proposed by Dusenberry in 1949. The key points are:
1) Dusenberry argued that consumption depends more on a person's relative income position compared to others in their community, rather than their absolute income level. People will consume more if they live in wealthier communities to maintain their standard of living.
2) In the short run, the average propensity to consume is greater than the marginal propensity to consume and the relationship between income and consumption is not proportional. In the long run, consumption increases proportionally with income and the average propensity to consume equals the marginal propensity to consume.
3) Dusenberry also believed consumption
Keynes proposed that as income increases, consumption increases but not as much as the rise in income, meaning the marginal propensity to consume is less than one. The relationship between consumption and income can be expressed as C=A+BY, where C is consumption, A is autonomous consumption, B is the marginal propensity to consume, and Y is real disposable income. When total income in a community increases, consumption spending also increases but to a lesser degree, so increased income is split between consumption and savings.
In Macroeconomics Income and Employment are interchangeable terms, since in the short-run National income depends on the total volume of employment or economic activity in the country. As income and employment are synonymous the employment theory is also called income theory.
It should be clear to readers that the classical economists did not formulate any specific theory of employment as such. They only laid down certain postulates which subsequently developed as a theory.
Domar's growth model from 1946 analyzes how a capitalist economy can grow at a constant rate after reaching full employment. It assumes aggregate supply equals aggregate demand during steady growth. The model shows that for steady growth, the rates of investment, capital stock growth, output growth, and employment growth must all be equal. It derives the equation that the growth rate equals the savings ratio multiplied by the incremental output-capital ratio. Investment has dual effects of increasing both aggregate demand and productive capacity in the long-run.
Consumption function shows the relationship between consumption and income. Keynes proposed the psychological law of consumption, which states that as income rises, consumption increases but by less than the rise in income. Consumption depends on both subjective psychological factors and objective external factors. The average propensity to consume is the ratio of consumption to income, while the marginal propensity to consume is the change in consumption from a change in income.
The neoclassical theory of interest, or loanable funds theory, holds that the interest rate is determined by the supply and demand for loanable funds. The demand for loanable funds comes from investment, consumption/dissaving, and hoarding. The supply comes from savings, bank credit, dishoarding, and disinvestment. The interest rate reaches equilibrium when the total demand for loanable funds equals the total supply. Critics argue the theory assumes full employment, does not precisely determine the interest rate, and is impractical.
Milton Friedman's monetarist theory of inflation argues that inflation is always caused by increases in the money supply. When the money supply increases, people's real cash balances exceed demand, so they spend more on goods and services, bidding up prices if output does not rise. The rate of inflation is determined by the rate of growth of the money supply minus the rate of output growth, with inflation directly related to money supply increases when the economy is at full employment. Friedman's theory modifies Keynes' ideas and assumes full employment, but critics argue it ignores fiscal policy and speculative demand for money.
This document discusses the dual gap analysis model for analyzing savings-investment gaps and foreign exchange gaps that constrain economic growth in developing countries. It explains that if a country's targeted growth rate requires higher investment than can be supported by domestic savings, there will be an ex-ante savings gap that can be filled by foreign aid inflows. Similarly, if the foreign exchange required for imports to support the targeted growth rate exceeds potential foreign exchange earnings, there will be an ex-ante foreign exchange gap that can also be filled by foreign aid. The dual gap analysis is useful for developing countries to estimate capital requirements and calculate how much investment and savings can be generated domestically versus relying on foreign resources.
This document discusses stabilization policy, which aims to stabilize the economy and prevent fluctuations in output, employment, and prices that occur during business cycles. Stabilization policy uses monetary policy, fiscal policy, and international measures. Monetary policy involves tools like changing interest rates, reserve ratios, and open market operations to influence the money supply. Fiscal policy involves manipulating public expenditure, taxation, and debt to stimulate or contract the economy. International measures coordinate import/export policies and currency values with other countries. The overall goal is to counteract inflation during booms and spur growth during recessions.
1. The document discusses general equilibrium theory (GET) and defines general equilibrium as a state where all markets and decision-making units are in simultaneous equilibrium.
2. It presents a simple two-sector general equilibrium model of an economy with two consumers, two goods, and two factors of production. Equations represent consumer demand, factor supply, factor demand, good supply, and market clearing for goods and factors.
3. With the number of equations equal to the number of unknowns, a general equilibrium solution exists in this Walrasian model under certain assumptions. GET provides a framework for understanding the complexity of economic systems through interdependent markets.
This document discusses the relationship between investment, national income, and the stock of capital over multiple time periods. It presents a formula to calculate the present value of future returns from a capital asset. It also shows a table illustrating how output, income, capital stock, replacement costs, net investment, and gross investment change over 6 time periods. The capital output ratio and depreciation rate are assumed to remain constant.
Permanent income hypothesis states that consumption is based on permanent income rather than current income. Permanent income refers to income that is expected to persist in the future, while transitory income does not persist. According to the hypothesis, people smooth consumption in response to transitory income variations by using savings and borrowing. The hypothesis assumes tastes and interest rates remain stable over time. In the short run, the consumption function shows consumption is less proportional to income than in the long run, where proportionality is achieved through savings adjustments. Critics argue the hypothesis ignores differences in preferences between rich and poor and does not account for effects of windfalls on consumption.
In economics, the theory of the second best concerns the situation when one or more optimality conditions cannot be satisfied.
The economists Richard Lipsey and Kelvin Lancaster showed in 1956, that if one optimality condition in an economic model cannot be satisfied, it is possible that the next-best solution involves changing other variables away from the values that would otherwise be optimal.
Politically, the theory implies that if it is infeasible to remove a particular market distortion, introducing a second (or more) market distortion may partially counteract the first, and lead to a more efficient outcome.
Public debt in India has increased over 7 times from 1990-1991 to 2005-2006. It includes money borrowed by the government through internal loans within India and external loans from international organizations. There are several types of public debt like short-term, long-term, productive and unproductive debts. While public debt allows the government to fund development projects, it also burdens citizens with increased taxes and can adversely affect growth. Proper management of public debt is needed in India through reducing expenditures, encouraging foreign investment, and monitoring public spending.
This document discusses equilibrium in consumption and production using an Edgeworth box model. It explains that equilibrium occurs where the indifference curves of two consumers are tangent, known as the contract curve. General equilibrium is achieved when the contract curve touches the production possibility frontier in the Edgeworth box, establishing equilibrium in both markets simultaneously. However, general equilibrium is not unique and depends on given prices; the model assumes perfect competition and does not explain price determination.
- Keynes proposed the consumption function which states that consumption is determined by current income and that the marginal propensity to consume decreases as income rises.
- Later studies using long time series data found that the average propensity to consume remained stable over time, contradicting Keynes' theory.
- Economists like Fisher, Modigliani, and Friedman developed models to explain long-run consumption behavior based on lifetime income and preferences for smoothing consumption over time. They argued consumption depends on permanent income rather than current income alone.
Lewis proposed that less developed countries could stimulate growth by exploiting their unlimited supplies of labor. His model assumes these countries have high populations engaged in subsistence work, making labor perfectly elastic at that wage. The economies are dual, with a subsistence sector employing most workers at low productivity and a capitalist sector using capital. Growth occurs as labor moves from subsistence to capitalist sectors, increasing output and allowing reinvestment which further raises productivity and employment in a self-sustaining cycle until labor pressures subside. Bank credit can also aid capital formation though inflation is self-correcting. Critics argue the model overlooks demand factors and difficulties transitioning large agricultural populations.
The Philip curve shows an inverse relationship between the rate of unemployment and the rate of change in money wages in the short run. Friedman argued that in the long run, there is no tradeoff between inflation and unemployment - the Philip curve becomes vertical at the natural rate of unemployment, which is the rate where expected and actual inflation are equal. Temporary reductions in unemployment below the natural rate are only possible if inflation rises above expectations, but eventually expectations will adjust and unemployment will return to the natural rate, even as inflation accelerates.
The document discusses the Solow growth model and how it can be used to analyze the effects of changes in saving and population growth rates on economic growth. It begins by introducing the basic Solow model framework, including the production function, capital accumulation equation, and steady state. It then shows graphically how the model transitions towards the steady state over time. The document also discusses how an increase in the saving rate leads to a higher steady state capital stock, output, and consumption. Finally, it analyzes the transition path following a reduction in the saving rate, with consumption initially rising but then capital, output, consumption, and investment falling as the economy moves to a new, lower steady state.
Permanent and Life Cycle Income HypothesisJosephAsafo1
The document discusses the Permanent Income Hypothesis (PIH) and Life Cycle Hypothesis (LCH). It explains that according to PIH, consumption is based on permanent income rather than current income. Current income has both permanent and transitory components. The LCH suggests that consumption varies over a person's life cycle as they save when young and spend when retired to maintain smooth consumption levels. The LCH consumption function shows consumption depends on both wealth and income levels over a person's lifetime.
This document discusses bilateral monopoly, which refers to a market situation with a single seller (monopolist) and single buyer (monopsonist) of a product. It outlines the assumptions of bilateral monopoly and describes how price and output are determined. Specifically, it notes that the monopolist will seek to sell at a higher price where marginal cost equals marginal revenue, while the monopsonist will seek to buy at a lower price where marginal expenditure equals marginal utility. The actual price and quantity transacted will depend on the relative bargaining strengths of the monopolist and monopsonist, settling somewhere between the two preferred prices.
This document discusses the balanced budget multiplier concept. It explains that an equal increase in government taxes and spending can result in a net increase in GDP. This is known as the balanced budget multiplier. The document provides an example where government spending increases by $50 million and taxes also increase by $50 million. This leads to an increase in GDP of $50 million, demonstrating that the balanced budget multiplier is equal to 1. So an increase in government spending that is fully financed by taxes will increase GDP by the same amount.
This document summarizes key points from a chapter about government debt. It discusses several topics:
1. The size of government debt in various countries, with Japan having the highest debt-to-GDP ratio at 159% and the U.S. at 64%.
2. Traditional and Ricardian views on the effects of government debt. The traditional view is that debt crowds out investment, while the Ricardian view is that debt has no real effects due to forward-looking consumers.
3. Problems in measuring budget deficits, such as not accounting for inflation, capital assets, or future liabilities for programs like Social Security. Correcting for these issues can significantly change deficit estimates.
The theory of multiplier and acceleration principle chapter 3Nayan Vaghela
The theory of multiplier and acceleration principle chapter 3, functioning of investment multiplier, the process of income generation through multiplier, acceleration principle, limitations of multiplier and acceleration.
The document discusses factors that determine the money supply and the money multiplier. It defines the monetary base (MB) as currency in circulation plus reserves, and M1 as currency plus checkable deposits. The money multiplier relates these, with M1 equal to the multiplier times MB. The multiplier depends on the currency ratio, reserve ratio, and excess reserves ratio. Changes in these ratios, such as due to bank panics, can impact the money supply by altering the multiplier. The Fed has more control over MB than M1 due to additional influencing factors.
The document discusses Keynes' conjectures about consumption and evidence for and against them. It also discusses alternative theories of consumption, including the life-cycle hypothesis and permanent income hypothesis.
Keynes conjectured that: 1) the marginal propensity to consume is between 0 and 1, 2) the average propensity to consume falls as income rises, and 3) income is the primary determinant of consumption. Early evidence supported these conjectures. However, later evidence challenged them, such as the failure of "secular stagnation" and studies finding a stable average propensity to consume over time.
Alternative theories emphasize consumption smoothing over a lifetime or in the face of temporary income changes. The life-cycle hypothesis predicts consumption
The document discusses theories of consumption, including Keynes' consumption function which posits that consumption is primarily determined by current income. It also discusses later developments like the life-cycle hypothesis and permanent income hypothesis which argue consumption depends on lifetime or permanent income rather than just current income. The document also examines consumer optimization using indifference curves and budget constraints over multiple time periods.
This document discusses the dual gap analysis model for analyzing savings-investment gaps and foreign exchange gaps that constrain economic growth in developing countries. It explains that if a country's targeted growth rate requires higher investment than can be supported by domestic savings, there will be an ex-ante savings gap that can be filled by foreign aid inflows. Similarly, if the foreign exchange required for imports to support the targeted growth rate exceeds potential foreign exchange earnings, there will be an ex-ante foreign exchange gap that can also be filled by foreign aid. The dual gap analysis is useful for developing countries to estimate capital requirements and calculate how much investment and savings can be generated domestically versus relying on foreign resources.
This document discusses stabilization policy, which aims to stabilize the economy and prevent fluctuations in output, employment, and prices that occur during business cycles. Stabilization policy uses monetary policy, fiscal policy, and international measures. Monetary policy involves tools like changing interest rates, reserve ratios, and open market operations to influence the money supply. Fiscal policy involves manipulating public expenditure, taxation, and debt to stimulate or contract the economy. International measures coordinate import/export policies and currency values with other countries. The overall goal is to counteract inflation during booms and spur growth during recessions.
1. The document discusses general equilibrium theory (GET) and defines general equilibrium as a state where all markets and decision-making units are in simultaneous equilibrium.
2. It presents a simple two-sector general equilibrium model of an economy with two consumers, two goods, and two factors of production. Equations represent consumer demand, factor supply, factor demand, good supply, and market clearing for goods and factors.
3. With the number of equations equal to the number of unknowns, a general equilibrium solution exists in this Walrasian model under certain assumptions. GET provides a framework for understanding the complexity of economic systems through interdependent markets.
This document discusses the relationship between investment, national income, and the stock of capital over multiple time periods. It presents a formula to calculate the present value of future returns from a capital asset. It also shows a table illustrating how output, income, capital stock, replacement costs, net investment, and gross investment change over 6 time periods. The capital output ratio and depreciation rate are assumed to remain constant.
Permanent income hypothesis states that consumption is based on permanent income rather than current income. Permanent income refers to income that is expected to persist in the future, while transitory income does not persist. According to the hypothesis, people smooth consumption in response to transitory income variations by using savings and borrowing. The hypothesis assumes tastes and interest rates remain stable over time. In the short run, the consumption function shows consumption is less proportional to income than in the long run, where proportionality is achieved through savings adjustments. Critics argue the hypothesis ignores differences in preferences between rich and poor and does not account for effects of windfalls on consumption.
In economics, the theory of the second best concerns the situation when one or more optimality conditions cannot be satisfied.
The economists Richard Lipsey and Kelvin Lancaster showed in 1956, that if one optimality condition in an economic model cannot be satisfied, it is possible that the next-best solution involves changing other variables away from the values that would otherwise be optimal.
Politically, the theory implies that if it is infeasible to remove a particular market distortion, introducing a second (or more) market distortion may partially counteract the first, and lead to a more efficient outcome.
Public debt in India has increased over 7 times from 1990-1991 to 2005-2006. It includes money borrowed by the government through internal loans within India and external loans from international organizations. There are several types of public debt like short-term, long-term, productive and unproductive debts. While public debt allows the government to fund development projects, it also burdens citizens with increased taxes and can adversely affect growth. Proper management of public debt is needed in India through reducing expenditures, encouraging foreign investment, and monitoring public spending.
This document discusses equilibrium in consumption and production using an Edgeworth box model. It explains that equilibrium occurs where the indifference curves of two consumers are tangent, known as the contract curve. General equilibrium is achieved when the contract curve touches the production possibility frontier in the Edgeworth box, establishing equilibrium in both markets simultaneously. However, general equilibrium is not unique and depends on given prices; the model assumes perfect competition and does not explain price determination.
- Keynes proposed the consumption function which states that consumption is determined by current income and that the marginal propensity to consume decreases as income rises.
- Later studies using long time series data found that the average propensity to consume remained stable over time, contradicting Keynes' theory.
- Economists like Fisher, Modigliani, and Friedman developed models to explain long-run consumption behavior based on lifetime income and preferences for smoothing consumption over time. They argued consumption depends on permanent income rather than current income alone.
Lewis proposed that less developed countries could stimulate growth by exploiting their unlimited supplies of labor. His model assumes these countries have high populations engaged in subsistence work, making labor perfectly elastic at that wage. The economies are dual, with a subsistence sector employing most workers at low productivity and a capitalist sector using capital. Growth occurs as labor moves from subsistence to capitalist sectors, increasing output and allowing reinvestment which further raises productivity and employment in a self-sustaining cycle until labor pressures subside. Bank credit can also aid capital formation though inflation is self-correcting. Critics argue the model overlooks demand factors and difficulties transitioning large agricultural populations.
The Philip curve shows an inverse relationship between the rate of unemployment and the rate of change in money wages in the short run. Friedman argued that in the long run, there is no tradeoff between inflation and unemployment - the Philip curve becomes vertical at the natural rate of unemployment, which is the rate where expected and actual inflation are equal. Temporary reductions in unemployment below the natural rate are only possible if inflation rises above expectations, but eventually expectations will adjust and unemployment will return to the natural rate, even as inflation accelerates.
The document discusses the Solow growth model and how it can be used to analyze the effects of changes in saving and population growth rates on economic growth. It begins by introducing the basic Solow model framework, including the production function, capital accumulation equation, and steady state. It then shows graphically how the model transitions towards the steady state over time. The document also discusses how an increase in the saving rate leads to a higher steady state capital stock, output, and consumption. Finally, it analyzes the transition path following a reduction in the saving rate, with consumption initially rising but then capital, output, consumption, and investment falling as the economy moves to a new, lower steady state.
Permanent and Life Cycle Income HypothesisJosephAsafo1
The document discusses the Permanent Income Hypothesis (PIH) and Life Cycle Hypothesis (LCH). It explains that according to PIH, consumption is based on permanent income rather than current income. Current income has both permanent and transitory components. The LCH suggests that consumption varies over a person's life cycle as they save when young and spend when retired to maintain smooth consumption levels. The LCH consumption function shows consumption depends on both wealth and income levels over a person's lifetime.
This document discusses bilateral monopoly, which refers to a market situation with a single seller (monopolist) and single buyer (monopsonist) of a product. It outlines the assumptions of bilateral monopoly and describes how price and output are determined. Specifically, it notes that the monopolist will seek to sell at a higher price where marginal cost equals marginal revenue, while the monopsonist will seek to buy at a lower price where marginal expenditure equals marginal utility. The actual price and quantity transacted will depend on the relative bargaining strengths of the monopolist and monopsonist, settling somewhere between the two preferred prices.
This document discusses the balanced budget multiplier concept. It explains that an equal increase in government taxes and spending can result in a net increase in GDP. This is known as the balanced budget multiplier. The document provides an example where government spending increases by $50 million and taxes also increase by $50 million. This leads to an increase in GDP of $50 million, demonstrating that the balanced budget multiplier is equal to 1. So an increase in government spending that is fully financed by taxes will increase GDP by the same amount.
This document summarizes key points from a chapter about government debt. It discusses several topics:
1. The size of government debt in various countries, with Japan having the highest debt-to-GDP ratio at 159% and the U.S. at 64%.
2. Traditional and Ricardian views on the effects of government debt. The traditional view is that debt crowds out investment, while the Ricardian view is that debt has no real effects due to forward-looking consumers.
3. Problems in measuring budget deficits, such as not accounting for inflation, capital assets, or future liabilities for programs like Social Security. Correcting for these issues can significantly change deficit estimates.
The theory of multiplier and acceleration principle chapter 3Nayan Vaghela
The theory of multiplier and acceleration principle chapter 3, functioning of investment multiplier, the process of income generation through multiplier, acceleration principle, limitations of multiplier and acceleration.
The document discusses factors that determine the money supply and the money multiplier. It defines the monetary base (MB) as currency in circulation plus reserves, and M1 as currency plus checkable deposits. The money multiplier relates these, with M1 equal to the multiplier times MB. The multiplier depends on the currency ratio, reserve ratio, and excess reserves ratio. Changes in these ratios, such as due to bank panics, can impact the money supply by altering the multiplier. The Fed has more control over MB than M1 due to additional influencing factors.
The document discusses Keynes' conjectures about consumption and evidence for and against them. It also discusses alternative theories of consumption, including the life-cycle hypothesis and permanent income hypothesis.
Keynes conjectured that: 1) the marginal propensity to consume is between 0 and 1, 2) the average propensity to consume falls as income rises, and 3) income is the primary determinant of consumption. Early evidence supported these conjectures. However, later evidence challenged them, such as the failure of "secular stagnation" and studies finding a stable average propensity to consume over time.
Alternative theories emphasize consumption smoothing over a lifetime or in the face of temporary income changes. The life-cycle hypothesis predicts consumption
The document discusses theories of consumption, including Keynes' consumption function which posits that consumption is primarily determined by current income. It also discusses later developments like the life-cycle hypothesis and permanent income hypothesis which argue consumption depends on lifetime or permanent income rather than just current income. The document also examines consumer optimization using indifference curves and budget constraints over multiple time periods.
The document summarizes theories of consumer behavior, including:
- Keynes' consumption function which proposed that consumption is determined by current income and the marginal propensity to consume falls as income rises.
- Fisher's model of intertemporal choice which introduced indifference curves and budget constraints to analyze consumption over time.
- Modigliani's life-cycle hypothesis and Friedman's permanent income hypothesis which argued consumption depends on lifetime/permanent income rather than current income alone.
1. The document discusses theories of consumption and investment in macroeconomics.
2. It covers Keynes' consumption function, the life cycle hypothesis, permanent income hypothesis, and relative income hypothesis as theories of consumption. It also discusses the accelerator theory and neoclassical theory as explanations of business fixed investment.
3. The theories attempt to explain factors that determine consumption and investment levels, such as income, wealth, interest rates, and expectations of future income. They seek to understand how consumption and investment influence economic growth and business cycles.
The current account, lrbc and consumption smoothingAsusena Tártaros
The document discusses the long-run budget constraint (LRBC) and how it relates to consumption smoothing. It shows that in an open economy, consumption can remain smooth even if there is a temporary shock to output, as the country can run a trade deficit financed by borrowing from abroad. However, for a permanent shock, both closed and open economies must cut consumption immediately and fully. Financial globalization thus allows countries to better cope with temporary fluctuations in output.
This document summarizes key aspects of an intertemporal model of a small open economy's current account. It introduces the model, which involves a two-period economy where households receive endowments and choose consumption and savings. It describes the sequential budget constraints, intertemporal budget constraint, indifference curves, and how households optimize consumption over time by equalizing the marginal rate of substitution to the interest rate. The document also notes some properties of small open economies and defines the interest rate parity condition.
AN ENQUIRY INTO CONSUMPTION THEORIES.pdfFinmonkeyIn
This document summarizes several prominent theories of consumption: Keynes' theory that current consumption depends on current income; Irving Fisher's intertemporal choice theory that current consumption depends on lifetime income; Franco Modigliani's life-cycle hypothesis that consumption depends on how income varies over one's lifetime; and Milton Friedman's permanent income hypothesis that consumption depends mainly on permanent rather than transitory income. It provides details on the key assumptions and implications of each theory.
- The document introduces a framework for analyzing intertemporal consumption and savings choices over two time periods (present/period 1 and future/period 2).
- It defines key concepts like income, wealth, budget constraints, and savings. The individual receives income in both periods and can save in period 1 to consume or repay debts in period 2.
- The individual's utility depends on consumption in both periods (c1 and c2). Budget constraints equate the individual's resources (income + savings + interest) to expenditures (consumption + savings carried to next period) in each period.
This document contains two economics exercises related to fiscal policy and government debt.
Exercise 1 asks the reader to analyze consumption and savings for an individual over two periods under different fiscal policy scenarios: (1) the government finances spending with taxes, (2) the government incurs debt to finance spending and taxes in the future, and (3) the individual faces liquidity constraints.
Exercise 2 asks the reader to (a) analyze how a reduction in interest rates would affect the primary surplus needed to maintain a stable debt-to-GDP ratio, (b) check the government's calculations to maintain stability with a given interest rate and growth rate, and (c) examine what would happen to the debt-to-
1) The document discusses consumption and saving over multiple time periods, presenting the household budget constraint equations for two periods and multiple periods.
2) It explains how the household chooses their consumption (C1 and C2) to maximize utility subject to the budget constraint, and how their consumption responds to changes in income and interest rates through income and substitution effects.
3) An increase in the interest rate (i1) motivates households to save more in the first period and consume more in the second period due to the substitution effect, and provides households income from their savings.
With the collapse of US mortgage market due to sub-prime lending, the global financial system is completely shattered. The UK financial markets were also not able to resist to this economy fall-down. The combination of credit crunch and falling housing market resulted in a recession in the UK market (Richardson, 2011). Recession can be defined as fall in real GDP of a country. Alternatively, it can be defined as, for the two consecutive quarters, if economic growth shows negative trend; i.e. if there is a fall in the real output of the country for consecutively six months (King and Cushman, 1997).
The document discusses government debt and perspectives on it. It covers measurement problems with the deficit figure due to inflation, business cycles, and uncounted liabilities. It also summarizes the traditional view that debt lowers national saving versus the Ricardian view that it does not affect saving. Most economists oppose a balanced budget rule as it hinders fiscal policy goals like stabilization.
1) The document discusses consumer equilibrium and demand curve based on the ordinal utility approach. It explains the concepts of income effect, substitution effect and price effect using diagrams.
2) The derivation of the demand curve shows the inverse relationship between price and quantity demanded through shifts in equilibrium along indifference curves as price changes.
3) Consumer surplus is defined as the excess amount a consumer is willing to pay for a good over the actual amount paid, which declines with higher consumption. It represents potential revenue that can be extracted under special conditions.
The document discusses fiscal policy and government budgets. It makes three key points:
1) In the short run, fiscal deficits can raise output, but the impact on investment is ambiguous. In the long run, lower investment implies lower growth.
2) For a government to stabilize its debt levels after a tax cut, it must eventually offset the tax cut with higher taxes to cover interest payments on accumulated debt. The longer it waits, the larger the needed tax increase.
3) Very high debt levels pose dangers as expectations of default can become self-fulfilling, forcing interest rates and debt levels ever higher in a vicious cycle. Maintaining moderate debt levels is important for fiscal sustainability.
Problem Set 4Due Tuesday, April 12ECON 434 Internati.docxsleeperharwell
Problem Set 4
Due: Tuesday, April 12
ECON 434: International Finance and Macroeconomics
Penn State: Spring, 2016
1. Government Budget Constraints. This problem looks at the feasibility constraints facing the
government and the sustainability of current-account balances. This will generalize some of the results
we obtained in class.
__ Consider an economy that lasts for N periods. In period t, the government purchases Gt dollars
worth of goods, and it collects Tt dollars worth of taxes. The government can also purchase B
g
t bonds
in period t; if it holds B
g
t bonds in period t, then it receives (1 + r)B
g
t bonds in period t + 1. (For
simplicity, assume that the interest rate r is constant.) If B
g
t < 0, then it means the government is in
debt.
(a) What is the government's period-t budget constraint? (Your answer should contain Gt, Tt, B
g
t ,
and r.)
(b) How do you compute the primary �scal de�cit in period t? How do you compute the secondary
�scal de�cit in period t?
(c) Combine the period budget constraints for t = 1, . . . ,N to show that:
B
g
0 +
N∑
t=1
Tt
(1 + r)
t
=
N∑
t=1
Gt
(1 + r)
t
+
B
g
N
(1 + r)
N
. (1)
(d) Suppose that N is a �xed, �nite number. What condition does B
g
N have to satisfy, and why?
(e) Individuals who pay taxes have �nite lives, but institutions, such as governments, can live a long
time, possibly forever. This leads to the possibility that a government could, in principle, keep
rolling over its debt, even as generations of citizens come and go.1 Mathematically, we model this
by letting N →∞. What condition does B
g
N
(1+r)N
have to satisfy as N →∞? Explain your answer
in words.
(f) Suppose that the government starts out in debt, with B
g
0 < 0. Is it possible for the government
to run primary de�cits forever? Why or why not?
(g) Now, suppose that the government starts out with positive assets B
g
0 > 0. We'll look at the case of
an in�nitely-lived government (N = ∞), and we'll assess whether it's possible for the government
to make purchases while never taxing its citizens (i.e., Tt = 0, for t = 1,2, . . .).
__ Consider the following plan. Before making purchases in period t, the government has
(1 + r)B
g
t−1 dollars at its disposal from the interest it earned on its previous period's assets.
The government decides to take a fraction δ of this money to spend on period-t government
purchases Gt; the remaining fraction 1−δ is used to buy more bonds.
i. Provide an expression for B
g
t in terms of B
g
t−1, and provide an expression for Gt in terms of
B
g
t−1. (Both expressions will depend on δ and r.)
ii. Provide an expression for B
g
t in terms of B
g
0 and t, and provide an expression for Gt in terms
of B
g
0 and t. (Both expressions will depend on δ and r.)
1For an example, see �The Case of the Undying Debt� by François Velde: https://www.chicagofed.org/publications/working-
papers/2009/wp-12.
1
iii. In each period t, does the government run a primary surplus or de�cit.
The document summarizes several economic theories of consumption:
1) John Maynard Keynes theorized that consumption depends on current income, while later models incorporated expected future income and wealth.
2) Irving Fisher introduced intertemporal choice theory, assuming consumers maximize lifetime utility subject to budget constraints.
3) Franco Modigliani's life-cycle hypothesis proposes consumption varies over a person's life cycle as they save during working years and dissave in retirement.
4) Milton Friedman's permanent income hypothesis views current income as having permanent and transitory components, with consumption based on permanent income.
This document provides an overview of the simple Keynesian model of income determination. It discusses the key components of aggregate expenditure, including consumption which depends on disposable income, and investment which depends on the marginal efficiency of capital and interest rates. The aggregate output is determined by the factors of production using a production function. Equilibrium income is reached at the point where aggregate expenditure and aggregate output intersect, establishing equilibrium in the goods market.
1. This chapter discusses several prominent theories of consumption, including Keynes' theory that current consumption depends on current income, Fisher's intertemporal choice theory, Modigliani's life-cycle hypothesis, Friedman's permanent income hypothesis, Hall's random-walk hypothesis, and Laibson's theory of instant gratification.
2. The theories attempt to explain empirical findings like the stability of the average propensity to consume and why consumption does not always rise as fast as income. Fisher's theory emphasizes lifetime income and intertemporal budget constraints, while Modigliani and Friedman focus on smoothing consumption in response to changing income over a lifetime or from temporary fluctuations.
3. Later theories incorporate rational expectations and
This document summarizes theories of consumption, saving, and investment. It discusses the Keynesian, permanent income hypothesis, and life-cycle models of consumption and saving behavior. Key factors that influence saving rates are discussed, including income levels, income uncertainty, demographic trends, government policies, financial development, and access to pensions/insurance. Empirical evidence generally finds higher saving rates in developing versus industrialized countries, especially in Asia, with foreign saving particularly important in Sub-Saharan Africa.
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Independent Study - College of Wooster Research (2023-2024) FDI, Culture, Glo...AntoniaOwensDetwiler
"Does Foreign Direct Investment Negatively Affect Preservation of Culture in the Global South? Case Studies in Thailand and Cambodia."
Do elements of globalization, such as Foreign Direct Investment (FDI), negatively affect the ability of countries in the Global South to preserve their culture? This research aims to answer this question by employing a cross-sectional comparative case study analysis utilizing methods of difference. Thailand and Cambodia are compared as they are in the same region and have a similar culture. The metric of difference between Thailand and Cambodia is their ability to preserve their culture. This ability is operationalized by their respective attitudes towards FDI; Thailand imposes stringent regulations and limitations on FDI while Cambodia does not hesitate to accept most FDI and imposes fewer limitations. The evidence from this study suggests that FDI from globally influential countries with high gross domestic products (GDPs) (e.g. China, U.S.) challenges the ability of countries with lower GDPs (e.g. Cambodia) to protect their culture. Furthermore, the ability, or lack thereof, of the receiving countries to protect their culture is amplified by the existence and implementation of restrictive FDI policies imposed by their governments.
My study abroad in Bali, Indonesia, inspired this research topic as I noticed how globalization is changing the culture of its people. I learned their language and way of life which helped me understand the beauty and importance of cultural preservation. I believe we could all benefit from learning new perspectives as they could help us ideate solutions to contemporary issues and empathize with others.
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"Does Foreign Direct Investment Negatively Affect Preservation of Culture in the Global South? Case Studies in Thailand and Cambodia."
Do elements of globalization, such as Foreign Direct Investment (FDI), negatively affect the ability of countries in the Global South to preserve their culture? This research aims to answer this question by employing a cross-sectional comparative case study analysis utilizing methods of difference. Thailand and Cambodia are compared as they are in the same region and have a similar culture. The metric of difference between Thailand and Cambodia is their ability to preserve their culture. This ability is operationalized by their respective attitudes towards FDI; Thailand imposes stringent regulations and limitations on FDI while Cambodia does not hesitate to accept most FDI and imposes fewer limitations. The evidence from this study suggests that FDI from globally influential countries with high gross domestic products (GDPs) (e.g. China, U.S.) challenges the ability of countries with lower GDPs (e.g. Cambodia) to protect their culture. Furthermore, the ability, or lack thereof, of the receiving countries to protect their culture is amplified by the existence and implementation of restrictive FDI policies imposed by their governments.
My study abroad in Bali, Indonesia, inspired this research topic as I noticed how globalization is changing the culture of its people. I learned their language and way of life which helped me understand the beauty and importance of cultural preservation. I believe we could all benefit from learning new perspectives as they could help us ideate solutions to contemporary issues and empathize with others.
Abhay Bhutada, the Managing Director of Poonawalla Fincorp Limited, is an accomplished leader with over 15 years of experience in commercial and retail lending. A Qualified Chartered Accountant, he has been pivotal in leveraging technology to enhance financial services. Starting his career at Bank of India, he later founded TAB Capital Limited and co-founded Poonawalla Finance Private Limited, emphasizing digital lending. Under his leadership, Poonawalla Fincorp achieved a 'AAA' credit rating, integrating acquisitions and emphasizing corporate governance. Actively involved in industry forums and CSR initiatives, Abhay has been recognized with awards like "Young Entrepreneur of India 2017" and "40 under 40 Most Influential Leader for 2020-21." Personally, he values mindfulness, enjoys gardening, yoga, and sees every day as an opportunity for growth and improvement.
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Well-crafted financial reports serve as vital tools for decision-making and transparency within an organization. By following the undermentioned tips, you can create standardized financial reports that effectively communicate your company's financial health and performance to stakeholders.
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Falcon stands out as a top-tier P2P Invoice Discounting platform in India, bridging esteemed blue-chip companies and eager investors. Our goal is to transform the investment landscape in India by establishing a comprehensive destination for borrowers and investors with diverse profiles and needs, all while minimizing risk. What sets Falcon apart is the elimination of intermediaries such as commercial banks and depository institutions, allowing investors to enjoy higher yields.
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1. Student number: 557699
Question A
Ricardian equivalence observes that, for a constant level of government expenditure, a cut in
current taxation followed by an increase in future taxes will have the same discounted present
value as the tax cut. Ricardo argued that both bond and tax financing of government
expenditure are equivalent; therefore a deficit financed cut in current taxes would have no
effect in either the short- or long-run. This means that governments shouldn’t worry about the
size of their deficit as it reflects the size of their spending. This arises because the present
value of taxes can only change if the government changes the present value of its spending,
which under Ricardian equivalence is assumed constant.
A fall in taxes which is financed by government bond issue will increase the current
disposable income for the population, however there is an increase in future tax liability to
cover both the interest payments on the new bonds and to pay the principal back from bonds
which have reached maturity. Because the discounted present value of the higher future tax is
equal to the tax cut, households are therefore no better or worse off by the reduction in
current taxation over the course of their life. This implication means that households will not
change their spending; however households will increase their saving by the full magnitude
of the reduction in taxes. Since the increase in household saving is exactly equal to the
increase in government bond issue (borrowing), the interest rate which clears the bond market
is unchanged as both the supply and demand for loanable funds schedules shift in equal and
opposite direction.
To illustrate that a bond financed tax reduction has no effect on private sector consumption
because private sector saving increases by the full extent of the bond issue; we can consider
households saving function which is given as
Where S1 is household saving, Y1 is household income for each period (given exogenously),
T1 is the initial level of taxation, and is household consumption. This is a standard savings
function which shows that households save what is left of their disposable income (
after consumption. Because the decrease in taxation is equal to the value of the bond issue
Where shows the post-cut tax level and B is bond issue. This gives the new savings
function post tax reduction, as
.
Using the previous formula to find the change to household saving then gives
.
This final equation shows that the value of the bond issue is equal to the increase in savings;
therefore household consumption, C1, does not change. This finding isn’t consistent with the
1
2. Student number: 557699
Keynesian viewpoint which would expect consumption to rise.
In multi-generational models where households have the opportunity for capital accumulation
over the generations, the above situation continues. Ricardian equivalence assumes that each
generation’s utility also depends on the utility of the next generation. This means that given
reduction in current taxes for generation 1, generation 1 will save the full amount of the
reduction in taxes which will be passed on to the next generation as gross bequest, which is
assumed to not be negative. The higher level of gross bequest, because of the higher savings,
means that the next generation can continue to consume at the same level as before the tax
cut. Therefore, there is no capital accumulation as the savings from the previous periods are
used up in next period consumption.
Question B
A liquidity constraint restricts a household’s ability to borrow against their period two
income to increase their period one consumption. The liquidity constraint can either
bebinding (which means that the household would like to borrow in period one but is unable
to due to the constraint) or it can be non-binding(which means that the constraint does not
affect the household’s consumption in either period).
Ahousehold which is subject to a binding liquidity constraint in period one by the constraint
will choose to consume all their disposable income of in period one.
The household’s budget constraint is given by the equation
Considering the graph below; without a liquidity constraint the household would use their
endowment income, E, to consume at point B which is where their utility is maximised on
utility curve U’.The individual would choose to consume at point B because that is where
their indifference curve is tangential to the non-liquidity constrained budget line YEBX.
Therefore because point B is to the right of the initial endowment point, the household would
choose to borrow if there is no liquidity constraint
However the liquidity constraint stops the household from borrowing against their period two
income which will kink the budget line from YEBX to YEC1. This occurs at point E because
the individual cannot borrow to increase their period one consumption and as such they
cannot have any more disposable income in period one. The highest possible indifference
curve that the household could reach is curve U1 which is tangential to the budget constraint
at point E. They cannot be made any better off as they cannot borrow to reach a higher
indifference curve, and if they saved their period one income they would be worse off as they
would be on a lower indifference curve. Therefore the household has chosen to consume at
point E, which means that they will be consuming all of their period one disposable income
in period one.
2
3. Student number: 557699
C2
Y
C2=Y2-T2 E
C 2’ B
U’
U1
C1
C1=Y1-T1 C1’ X
From looking at the two consumption points B and E, it is clear to see that the liquidity
constraint is making the household worse off as they are now consuming on a lower
indifference curve U1<U’.
If the government decided to implement a bond-financed reduction in period one taxation
which would be followed by an increase in period two taxation such that the taxes are now
and
The new intertemporal budget constraint is given by
This new budget constraint is exactly the same as the original before tax reduction budget
constraint as the B’s cancel out. Therefore the budget constraint does not move or shift.
However, the endowment point shifts down and to the right along the budget line as period
one income increases whilst period two income reduces.
We can see the effects of this bond financed tax reduction on the next graph and we will
consider two separate situations (1) a small reduction in taxation, and (2) a larger reduction in
taxation.
3
4. Student number: 557699
C2
Y
E E’
C2*=Y2-T2*
C2’ B
’
U’U*
E’’ U1
C1
C1 C1* C1’ X
’
First we can examine the effects of a small reduction in period one taxation.The original
endowment point E is now shifted to the right to point E’, which has a higher period one
income and lower period two income than the original endowment point. This household
would still prefer to borrow in period one if there was no liquidity constraint, however
because of this constraint they will use all of their period one income to consume at the new
endowment point E’, on utility curve U*. Because the individual has a preference towards
period one consumption, this situation yields a higher level of utility than before since
U*>U1. Again, to reach a higher indifference curve would mean violation of the liquidity
constraint and they could not save any of their period one income as it would make them
worse off. Therefore the liquidity constraint is still binding in this situation and their
consumption function is and .
The situation is quite different when the government makes a larger tax cut. If the cut is large
enough to shift the endowment point further to the right such that it is to the right of point B,
such as point E’’. In fact any point to the right of the optimum point if there is no liquidity
constraint (point B here), will end up with the household being a saver once there is a
liquidity constraint imposed. From this initial endowment point, the household would
actually save some of their period one income such that they would shift back along the
budget line until point B which is where the utility curve U’ is tangential to the budget
constraint. Therefore, the liquidity constraint is not binding in this situation, as the household
has been able to increase their utility regardless of the liquidity constraint.
The consequences of these findings for Ricardian equivalence are that it is not realistic. In
real life a household is not concerned with the value of their lifetime income; instead they are
most concerned with their current consumption. As such a household who needs to consume
4
5. Student number: 557699
more than their current income must borrow in order to sustain this consumption. If they are
impaired from borrowing to supplement their current income, the household’s current income
is the only thing which determines their consumption, irrespective of their future income.
We can see how Ricardian Equivalence could breakdown because of liquidity constraints if
we consider a young student who is currently at university with a part time job but who has a
job lined up for when he leaves university which will have a significantly higher income than
he currently earns. This individual may want to borrow against his expected higher future
income in order to smooth his consumption or pay for a holiday. However because of
liquidity constraints, such as imperfect financial markets or asymmetry in the information
between people looking to borrow or lend; this individual cannot secure a loan. Once the
government carries out the bond-financed tax reduction followed by a future tax increase, he
is not likely to increase how much he saves by the same value as the tax cut because instead it
will be a relief from his liquidity constraint so that he can consume more this period. This
would be against Ricardian Equivalence which expects that savings increase by the same
amount as the tax cut, but it will favour the Keynesian viewpoint which expects consumption
to increase. Consequently national savings and the government’s current account would
decline in value because of both government savings reducing and no change in private
saving.
Therefore when a bond financed tax reduction is implemented, households will have higher
current income and current consumption even though their future income will be reduced.
This means that the government is essentially giving the household a loan because of the
lower current tax and higher future taxes.
5