macroeconomics - licence 1 economie gestion - chapter 2...

Households’ consumptionConsumption function

Macroeconomics - Licence 1 EconomieGestion

Chapter 2: Consumption

Rémi Bazillier 1

1 [email protected]://remi.bazillier.free.fr

Université d’Orléans

Rémi Bazillier Chapter 2: Consumption

[email protected]

http://remi.bazillier.free.fr


Plan

1 Households’ consumptionPropensities to consume and Engel Laws

2 Consumption functionKeynesian consumption functionRelative income theoryInertia effectPermanent income theory



Introduction

In 2003, households’ consumption accounts for 58.3% ofthe European GDP... In the US: 70%How to explain such differences?



Propensities to consume and Engel Laws

Households’ consumption

Households’ consumption: definitionConsumption of a good is the quantity of this good which fulfillsthe needs of households without increasing production.

Final consumption of goods and services 6= Consumptionof intermediate goodsAt the country level: final consumption = consumption ofhouseholds and public administrations





Methodological difficulties to estimate real expenses ofhouseholds

Some expanses are not financed by the beneficiaries (eg.health or education): socialized part of consumptionStatistical definition of consumption expenses: directlyborne by households. It includes health and educationexpenses direcly paid by households (eg. student fees).





Effective consumption: all households’ consumption(and not only the share directly paid by households) =consumption expanses + Public spendings directly affectedto the households (health, education)





Source: Report by the Commission on the Measurement of EconomicPerformance and Social Progress (Stiglitz, Sen, Fitoussi, 2009)





Average propensity to consume:

APC =CY

(1)

Share of the income spent in consumptionMarginal propensity to consume:

MPC =∆C∆Y

= c (2)

Measure the evolution of consumption explained by agiven evolution of the income.




Engel Laws

Engel LawsRanking of consumption goods according to their income elasticity.As income rises, the proportion of income spent on foods falls, even ifabsolute expenditure on food rises. The income elasticity of consumption offood is between 0 and 1.

Income elasticity of consumptionVariation in percentage of consumption when income increases by 1%.Income elasticity of consumption is the ratio of marginal propensity toconsume over the average propensity to consume.

ε =∆C∆Y

/CY

=∆C∆Y

.YC

=∆CC

.Y

∆Y=

∆CC

/∆YY

(3)




Typology of goods and income elasticities ofconsumption

Inferior goods: consumption falls when income rises ε < 0Normal goods: consumption increases when incomeincreases (but less than the increase of income) 0 < ε ≤ 1Luxury goods: Consumption increases more thanproportionally than income ε > 1



Keynesian consumption functionRelative income theoryInertia effectPermanent income theory

Keynesian consumption function

Consumption is mainly a function of real income, notnominal incomePsychological fundamental law: “In average, whenincome is increasing, consumption increases but less thanthe increase of income.”→ MPC is included between 0 and 1if MPC < 1, APC is decreasing




Psychological fundamental law

C = C(Yd ) (4)

C = C0 + cYd (5)

with, C the level of consumption; Y the disposable income(After taxes: Yd = Y − T ); C0 fixed consumption; c, themarginal propensity to consume




Keynesian consumption function




5 characteristics of the Keynesian consumptionfunction

If Yd = 0→ C > 0 (fixed consumption: subsistence level)A rise of income→ Fall of APC

Y2: APC = C2Y2> 1→ Negative saving

Y1: APC = 1→ Consumption = incomeY > Y1 → APC < 1→ positive saving

The sum of APC and APS (average propensity to save) isequal to 1

Yd = C + S1 = C

Yd+ S

Yd

→ Average propensity to save is increasing with the level ofincome




5 characteristics of the Keynesian consumptionfunction

The slope of the consumption function is equal to the MPC.According to the fundamental psychological law, the slopeis included between 0 and 1

RemarqueY=C+S

∆Yd = ∆C + ∆S1 = ∆C

∆Yd+ ∆S

∆Ydc + s = 1 with s the marginal propensity to save

From the consumption function, we can build the savingfunction




Saving function

From the consumption function, we can build a saving function:

S = Yd − C (6)

(Y − T ) = C + S (7)(Y − T ) = cO + c(Y − T ) + S (8)

S = (1− c)(Y − T )− CO (9)




Different conception of savings

For the classics: saving is a postponed consumptionFor Keynes: saving is a giving up of consumption(“Individual saving means a decision to not have a dinnertoday”)For the classics: no depressive effect of saving. Moresaving→ more investment (link saving - investmentthrough the interest rate)For Keynes: saving is a function of income. No direct linksaving - investment through the interest rate




Equality S=I

Production approach of GDP:

Y = C + I + G (10)

Income approach of GDP:

Y − T = C + S (11)

C + I + G = C + S + T (12)I = S + (T −G) (13)

If no public deficit (G=T)→ I=S

S = I + (G − T ) (14)




S=I (if G-T=0)

Accounting equilibrium: S=IClassic view: ∆S ⇒↓ i → ∆I ⇒ ∆YKeynesian view: ∆I ⇒ ∆Y ⇒ ∆S




Is the marginal propensity to consume really constant?

Keynes acknowledges that it is most probably not the caseConstant in the short run / decreasing in the long run




Validity of the Keynesian analysis of consumption

Kuznet’s paradoxKuznets (1946): over a period of 70 years→ AMC is stable(around 0.9).

Stability of the saving rate and saving behavior in thelong-run: may be explained by life cycle theory and thetheory of permanent incomeIn the short run, no relation between variation of incomeand variation of consumption: may be explained by theoryof relative income




Consommation et épargne à LT




Relative income theory (Duesenberry, 1949)

2 hypothesis:1 Individuals are sensitive to the relative consumption. They

compare their expenses with the ones of other consumers2 When income rises, households adapt immediately their

level of consumption. But when income falls, they reducetheir saving in order to maintain their living standards

Level of consumption for one period is a function of thehighest level of income obtained in the past. relativeincome is an important determinant of consumption




Relative income theory




Inertia effect (Brown 1952)

Consumption is a function of income but we have tointroduce a lag to take into account an inertia in theconsumption behaviourConsumption is a function of income and of the last periodconsumptionIn the short run, we then have:

Ct = C0 + cYt + aCt−1 (15)

with 0 < c < 1 and 0 ≤ a < 1




Inertia effect(Brown 1952)

In the long-run: consumption function –>C = C0 + cY + aC–> Ct = c

1−aYt + C01−a

MPC = c1−a > c (MPC short run)




Life cycle theory (Modigliani 1963)





Introduce wealth as an addition explanation ofconsumptionMay solve the Kuznets paradox

C = aY + b(W/P) (16)

with Y , the real available income, W/P real wealth, a marginalpropensity to consume income, b marginal propensity toconsume wealth





Estimation of this function by Ando and Modigliani in astudy on American consumption between 1953 and 1973

C = 0.70Y + 0.06(W/P) (17)

But role of wealth lower in France and Europe




Permanent income theory (M. Friedman 1957)

Income: transitory income and permanent income

Permanent income: anticipation by consumers of their incomecoming from labor and their accumulated wealth

Difficult to estimate this wealth→ Approximation of thepermanent income by a weighted average of the current incomeand past income

Yp = aYt + (1− a)Yt−1 (18)

Transitory income is unpredictable (exceptional bonus...). Doesnot have any influence on the consumption.





Households consume a constant share of their permanentincome:

C = αYp (19)

where α is the average propensity to consume thepermanent incomeAPC=MPCConsumption function is proportional to the permaentincomePropensity to consume and saving rates are constant




In conclusion, Consumption’s determinants of Frenchhouseholds (1972-2003)

1 In the short run, real available income is the most importantdeterminant. MPC=0.8

2 An increase of the interest rate of 1 point increases the saving rate by0.2

3 Pigou effect: incentive to save during inflation period. But small effectsin France (1% rise of inflation→ 0.06% rise of saving

4 No consensual conclusions on the effect of wealth5 Unemployment and saving: no causality links


macroeconomics - licence 1 economie gestion - chapter 2...

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