Macroeconomics Chapter 9 Terms and Questions

What is the price of future consumption in terms of current consumption?

1 unit of current consumption for 1 + r units of future consumption.

What factors are important to a consumer in making his or her consumption-savings decision?

1. Consumer's preference for present versus future consumption: the more future consumption is preferred, the larger the saving 2. Consumer's current & future incomes: the larger is current income, the larger the saving 3. The real interest rate: the greater the interest rate, the larger the saving

Show how to derive the consumer's lifetime budget constraint from the consumer's current-period and future-period budget constraints

1. Current period budget constraint: c+s = y-t 2. Future period budget constraint: c' = y'-t'+(1+r)*s 3. s = (c' - y' + t')/(1 + r) 4. Plug s back into the current period budget constraint. 5. c + (c'/(1+r)) = y + (y'/(1+r)) - t - (t'/(1+r)) 6. Realize that the present value of lifetime consumption is equal to the present value of lifetime income minus the present value of lifetime tax payments.

Why do consumers save?

Consumers save because, they do not wish to consume all of their current income, and prefer to use some current income to increase their future consumption. In other words, they save to smooth their consumption over time.

How do consumers save in the two-period model?

Consumers save by choosing not to consume their entire income in the current period. They lend the excess of income over current consumption in the credit market, thereby increasing their future period income by the amount of the saving, with interest added. Thus, they can consume more than their income in the future period.

What is the slope of a consumer's lifetime budget constraint?

Equation in slope-intercept form: c' = -(1+r)*c + we(1+r) Where r is real interest rate, we is consumer's lifetime wealth, c is current consumption, and c' is future consumption.