Economics 302 (Sc. 001) Inrmdia Macroconomic Thory and Policy (Spring 2011) 3/28/2012 Insrucor: Prof. Mnzi Chinn Insrucor: Prof. Mnzi Chinn UW Madison
16 1 Consumpion Th Vry Forsighd dconsumr A vry forsighd consumr who dcids how much o consum basd on h valu of his oal walh, which compriss: 1. Th valu of his nonhuman walh, or h sum of financial walh and housing walh. 2. Th valu of his human walh and nonhuman walh oghr givs an sima of his oal walh. C = C( Toal walh ) Human walh is h Prsn Discound Valu of afr ax labor incom; for $40K Ch.00$, incom growh = 0.03, =0.25, r = 0.0 VY ( T) = ($40, 000)( 0. 75)( 72. 2) = $2, 166, 000 L 2of 27
16 1 Consumpion Toward a Mor Ralisic i Dscripion i W wan o smooh consumpion Bu somims w can bcaus of borrowing consrains And w migh b risk avrs C = C ( Toal walh, Y T) LT Y L = ral labor incom in yar. Y T = ral axs in yar. T = human walh, or h xpcd prsn valu LT of afr ax labor lb incom 3of 27
Consumpion Smoohing
Consumpion 9.3 9.2 9.1 9.0 Log consumpion and n worh bn 2005$ 11.1 11.0 10.9 10.8 8.9 10.7 8.8 8.7 Consumpion [lf axis] Houshold n worh [righ axis] 10.6 10.5 8.6 10.4 8.5 10.3 8.4 10.2 90 92 94 96 98 00 02 04 06 08 10 12 Sourc: BEA, 2011Q4 2nd rlas; Fd Flow of Funds.
16 1 Consumpion Puing Things Toghr: Currn Incom, Expcaions, and Consumpion This dpndnc of consumpion on xpcaions has wo main implicaions for h rlaion bwn consumpion and incom: 1. Consumpion is likly o rspond lss han on for on o flucuaions in currn incom. 2. Consumpion may mov vn if currn incom dos no chang. Consumpion may mov vn if currn incom dos no du o changs in consumr confidnc. 7of 27
16 2 Invsmn Th Prsn Vl Valu of Expcd dprofis 8of 27 V(Π ): Th prsn valu, in yar, of xpcd profi in yar +1 quals: In yar +2, In yar, 1 1+ r Π + 1 1 (1 ) (1 + r)(1 + r ) + 1 δ Π + 2 1 1 V ( Π ) = Π (1 δ ) Π + + 1 + 2 1 + r (1 + r)(1 + r ) Rasonabl valus for δ ar bwn 4 and 15% for machins, and bwn 2 and 4% for buildings and facoris. + 1
16 2 Invsmn Th Prsn Valu of Expcd Profis Figur 16 1 Compuing h Prsn Valu of Expcd Profis 9of 27
ThInvsmn Dcision 16 2 Invsmn I = I V Π ( ) ( + ) A Convnin Spcial Cas Suppos firms xpc boh fuur profis and fuur inrs ras o rmain a h sam lvl as oday, so ha Π =Π =... = Π + 1 + 2 r = r =... = r + 1 + 2 Economiss call such xpcaions xpcaions ha h fuur will b lik h prsn saic xpcaions. Undr hs wo assumpions, w g Π V ( Π ) = r + δ 10 of 27
A Convnin Spcial lcas I 16 2 Invsmn Π Puing ( V Π ) = and oghr giv us r + δ I = I[ V( Π )] an quaion for invsmn: = I Π r + δ Rnal Cos = ( r + δ ) Firms may b rlucan o borrow if currn profi is low. Bu if currn profi is high, h firm may no nd o borrow o financ is invsmns. Evn if h firm wans o invs, i migh hav difficuly borrowing. Ponial lndrs mayno b convincd h projcisasgood as h firms says. I = I [ V ( ), Π ] ( +, + ) 11 of 27
Currn vrsus Expcd Profi Figur 16 2 Changs in Invsmn and Changs in Profi in h Unid Sas sinc 1960 16 2 Invsmn Invsmn and profi mov vry much oghr. 12 of 27
Profi and Sals Sl Figur 16 3 Changs in Profi pr Uni of Capial vrsus Changs in h Raio of Oupu o Capial in h Unid Sas sinc 1960 16 2 Invsmn Profi pr uni of capial and h raio of oupu o capial mov largly oghr. Π = Π Y K ( + ) 13 of 27
16 3 Th Volailiy of Consumpion and Invsmn L s s look a h similariis bwn our ramn of consumpion and of invsmn bhavior: Whhr consumrs prciv currn movmns in incom o b ransiory or prmann affcs hir consumpion dcisions. In h sam way, whhr firms prciv currn movmns in sals o b ransiory or prmann affcs hir invsmn dcisions. 14 of 27
16 3 Th Volailiy of Consumpion and Invsmn Bu hr ar also imporan diffrncs bwn consumpion dcisions and invsmn dcisions: Whn facd wih an incras in incom ha consumrs prciv as prmann, hy rspond wih a mos an qual incras in consumpion. Whn firms ar facd wih an incras in sals hy bliv o b prmann, hir prsn valu of xpcd profis incrass, lading o an incras in invsmn. 15 of 27
16 3 Th Volailiy of Consumpion and Invsmn Figur 16 4 Ras of Chang of Consumpion and Invsmn sinc 1960 Rlaiv movmns in invsmn ar much largr han rlaiv movmns in consumpion. 16 of 27
16 3 Th Volailiy of Consumpion and Invsmn Th figur yilds ild hr conclusions: Consumpion and invsmn usually mov oghr. Invsmn is much mor volail han consumpion. Bcaus, howvr, h lvl of invsmn is much smallr han h lvl of consumpion, changs in invsmn from on yar o h nx nd up bing of h sam ovrall magniud as changs in consumpion. 17 of 27