What Is The Consumption Smoothing
Why is consumption smoothing?
The consumption function plays a major role in GDP of macroeconomy. Hence, its stability is of great importance to a country’s economy. The economist Irving Fisher proposed “Intertemporal choice” is the study of the relative value people assign to two or more payoffs at different points in time. Most choices require decision-makers to trade-off costs and benefits at different points in time. (Fisher, 1930) According to
Fisher’s model, economists Franco Modigliani created a life-cycle hypothesis.
(Modigliani 1954) In 1957, Milton Friedman established the permanent-income hypothesis that complements Modigliani’s life-cycle hypothesis. This essay will firstly show the comparison between UK and US consumption data. It will then mention what is consumption smoothing and talk about intertemporal based theories.
Finally, it will explain this consumption phenomenon by using a thorough understanding of inter-temporal choice.
12
10
8
UK
6
US
4
2
0
C/Y
G/Y
I/Y
(Comparison between UK and USA nearly 50 years Consumption data)
From 1950 to 2005, the US GDP raised from $293.8 billion to $12487.1 billion. But why consumption ratio decreased from 53.8% to 50.7%? (Highbeam 2005) By my count as shown in the figure, both UK and US the volatility of the consumption-output ratio is approximately equal to 0.05. However, the volatility of investment-output ratio is 0.11 and 0.088, almost two times of consumption-output ratio. Which indicates consumption appears to be less volatile than output and investment -----Consumption smoothing. (Karadimitropoulou 2013)
Consumption smoothing is the economic concept used to desire of people to have a stable path of consumption. (Wikipedia) Fisher’s theory argues that consumption
decisions are inter-temporal decisions. The reason people consume less than they desire is that their consumption is limited by their income, called a budget constraint.
When consumers decide how much they spend today versus how much they
The consumption function plays a major role in GDP of macroeconomy. Hence, its stability is of great importance to a country’s economy. The economist Irving Fisher proposed “Intertemporal choice” is the study of the relative value people assign to two or more payoffs at different points in time. Most choices require decision-makers to trade-off costs and benefits at different points in time. (Fisher, 1930) According to
Fisher’s model, economists Franco Modigliani created a life-cycle hypothesis.
(Modigliani 1954) In 1957, Milton Friedman established the permanent-income hypothesis that complements Modigliani’s life-cycle hypothesis. This essay will firstly show the comparison between UK and US consumption data. It will then mention what is consumption smoothing and talk about intertemporal based theories.
Finally, it will explain this consumption phenomenon by using a thorough understanding of inter-temporal choice.
12
10
8
UK
6
US
4
2
0
C/Y
G/Y
I/Y
(Comparison between UK and USA nearly 50 years Consumption data)
From 1950 to 2005, the US GDP raised from $293.8 billion to $12487.1 billion. But why consumption ratio decreased from 53.8% to 50.7%? (Highbeam 2005) By my count as shown in the figure, both UK and US the volatility of the consumption-output ratio is approximately equal to 0.05. However, the volatility of investment-output ratio is 0.11 and 0.088, almost two times of consumption-output ratio. Which indicates consumption appears to be less volatile than output and investment -----Consumption smoothing. (Karadimitropoulou 2013)
Consumption smoothing is the economic concept used to desire of people to have a stable path of consumption. (Wikipedia) Fisher’s theory argues that consumption
decisions are inter-temporal decisions. The reason people consume less than they desire is that their consumption is limited by their income, called a budget constraint.
When consumers decide how much they spend today versus how much they