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ECO209 - OCT 15.docx

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ECO209 – Oct 15 Lecture 4 – Introduction of the rate of interest • Start with a closed economy • How consumption might depend on the rate of interest o The inter-temporal consumption model  As rate of interest increases, the individual save more and consume less in order to consume more tomorrow; a greater return  The rate of growth of savings becomes larger  Is it realistic?  Saving is always a residual o Divide consumers into three main groups  1) high income, have the capacity to save • Satisfy all their needs and there are always money left • Cannot save everything • Buying houses is not consumption, considered as investment • Will save independently of rate of interest  2) low income, have no capacity to save • No capacity to borrow either o No secure job, hard to obtain a loan from bank for consumption  3) medium income, capacity to get into debt (full time job), may not have the capacity to save • Reallocate expenditure • Saving/consumption will depend on the rate of interest • When rate of interest goes down, those with capacity to get into debt will consume more, and save less o Total effect on the economy: total saving decreases as rate of interest goes down  Those who save will save in the same amount  Those who borrow will borrow even more • C= Cbar + cTRbar-cTbar + c(1-t)Y-di o Cbar: o Introduce –di where d=delta c/delta i o Simplifying assumption: assume consumption does not depend on the rate of interest
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