ch7.ppt

Macroeconomics Chapter 7 Consumption and Saving Household budget constraint C + (1/P) · ?B+ ?K = π/P + ( w/P )·L + i·( B/P + K) π /P = 0 C+(1/P)·?B+?K=(w/P)·L+i·(B/P+K) consumption+ real saving = real income Consumption and Saving Consumption and Saving Consumption Over Two Years Year1 C1 + ( B1/ P + K1) ? ( B0/ P + K0) = ( w/P)1 · L + i0 · ( B0/ P + K0) consumption in year1 + real saving in year1 = real income in year1 Year2 C2 + ( B2/ P + K2) ? ( B1/ P + K1) = ( w/ P) 2 · L + i1 · ( B1/ P + K1) consumption in year 2 + real saving in year 2 = real income in year 2 Consumption and Saving Consumption Over Two Years Combine the budget constraints to describe a household’s choice between consuming this year, C1, and next year, C2. B1/P + K1 = B0/P + K0 + i0·(B0/P + K0) + ( w/P)1·L? C1 Real assets end year1 = real assets end year0 + real income year1 ? consumption year1 Consumption and Saving Consumption and Saving Consumption and Saving Consumption Over Two Years B1/P + K1 = (1+i0) · (B0/P + K0) + (w/P)1 · L ? C1 B2/P + K2 = (1+ i1) · (B1/P + K1) + (w/P)2 · L ? C2 B2/P + K2 = (1+i1) · [(1+i0)·( B0/P + K0) + (w/P)1·L ? C1] + (w/P)2 · L ? C2 Consumption and Saving Consumption Over Two Years C2+(1+i1)· C1 = (1+i1)·(1+i0)·(B0/P+K0) +(1+i1)·(w/P)1·L+(w/P)2·L - (B2/P + K2) Two-year household budget constraint: C1 + C2/(1+i1) = (1+ i0)·(B0/P+K0) + (w/P)1·L+(w/P)2·L/(1+i1)?(B2/P+K2)/(1+i1) Consumption and Saving Present value If the interest rate, i1, is greater than zero, $1 received or spent in year 1 is equivalent to more than $1 in year 2. Dollars received or spent in year 2 must be discounted to make them comparable to dollars in year 1. The term 1+i1 is called a discount factor. Consumption and Saving Household chooses the time path of consumption—in this case, C1 and C2—to maximize utility, subject to the budget co