ch16 Household and Firm Behavior in the Macroeconomy A Further Look.pptVIP

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ch16 Household and Firm Behavior in the Macroeconomy A Further Look.ppt

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ch16 Household and Firm Behavior in the Macroeconomy A Further Look

Prepared by: Fernando Quijano Shelly Tefft;;life-cycle theory of consumption A theory of household consumption: Households make lifetime consumption decisions based on their expectations of lifetime income. ;In their early working years, people consume more than they earn. This is also true in the retirement years. In between, people save (consume less than they earn) to pay off debts from borrowing and to accumulate savings for retirement.;Demographics and both legal and illegal immigration play a role in determining the size of the labor force. Behavior also plays a role. Consumption cannot be considered separately from labor supply because it is precisely by selling your labor that you earn income to pay for your consumption.;nominal wage rate The wage rate in current dollars.;nonlabor, or nonwage, income Any income received from sources other than working—inheritances, interest, dividends, transfer payments, and so on. ;A rise in the interest rate leads you to consume less today and save more. This effect is called the substitution effect.;How does a household respond when it is constrained from working as much as it would like? It consumes less.;Recall the Keynesian theory that current income determines current consumption. Although consumption and labor supply decisions depend on the real wage rate, if there is unemployment, income depends on the employment decisions made by firms and not on household decisions. Developed during a period of unemployment, Keynesian theory is considered to pertain to those periods.;The following factors affect household consumption and labor supply decisions: Current and expected future real wage rates Initial value of wealth Current and expected future nonlabor income Interest rates Current and expected future tax rates and transfer payments;Over time, expenditures on services and nondurable goods are “smoother” than expenditures on durable goods.;The more nuanced theory of consumption that we have explored in thi