ECO 304L Lecture Notes - Lecture 11: Budget Constraint, Open Economy, Loanable Funds
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10 May 2017
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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. The present value of consumption equals the present value of disposable income. Household does not leave any wealth to heirs. Open economy: y + nfia = gnp. Household sector"s net taxes (assuming int = 0) Current net taxes: t = tax - tr. Expected future net taxes: t f = tax f - tr f. Disposable income: yd = y - t. 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. Same level of consumption in two periods.
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