EC390 Chapter Notes - Chapter 21: Real Interest Rate, Consumer Confidence

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8 Jan 2017
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Permanent income theory of consumption: consumers look beyond current income. Life cycle theory of consumption: consumers" planning horizon is their entire lifetime. Financial wealth and housing wealth: stocks and bonds, chequing and savings accounts, house and cars. Present value of expected after-tax labour income. Total wealth = human wealth + nonhuman wealth. Total wealth is the sum of nonhuman wealth (financial plus housing wealth) and human wealth (the expected present value of after-tax labour income) Consumption is an increasing function of total wealth and of current after-tax labour income. Expectations affect consumption in two ways: directly through human wealth, indirectly through nonhuman wealth. Two main implications: consumption is likely to respond less than one for one to fluctuations in current income, consumption may move even if current income does not change, consumer confidence. Investment depends on the real current interest rate and the current level of sales.

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