ECO 304L Lecture 11: Lecture 11 Notes

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Course Code
ECO 304L
M O S T A S H A R I, S H A L A H

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● Household budget assumptions ○ Household has no assets at beginning of period ○ Present and future variables are real, not nominal ○ The household can borrow and lend funds at interest rate r ○ Time period assumptions ■ Current and future ■ Working and retirement ■ Student and working ○ The present value of consumption equals the present value of disposable income ■ Household does not die in debt ■ Household does not leave any wealth to heirs ● Income ○ Current income ■ Closed economy: Y = GDP ■ Open economy: Y + NFIA = GNP ○ Expected future income: Y​ ● Household sector’s net taxes (assuming INT = 0) ○ Current net taxes: T = TAX - TR ○ Expected future net taxes: T​ = TAX​ - TR​ ● Consumption ○ Current consumption: C f ○ Planned future consumption: C​ ● Disposable Income: YD = Y - T ● Wealth Effect ○ If households feel wealthier, they may save less out of current income and consume at least as much as before ○ If assets or wealth decrease, consumption decreases and savings out of disposable income increase ● Consumption-Smoothing: Theory that households want to maintain similar standards of living (consumption) over their lifetime ○ Budget constraint only tells what is affordable, not necessarily what is chosen ○ Assumptions ■ Same level of consumption in two periods ● C = C​ ● Consumption point must lie on 45 degree line ■ Households are willing to postpone consumption today in exchange for a bigger increase in future consumption
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