chapter 9-Two Period Model

Intertemporal Decisions

choices that involve trade-offs across different time periods, like choosing between consuming now or later.

consumption savings decision

the consumer’s choice about how much to consume now and how much to save for the future

two-period model

a simplified model with just two time periods, the current period and the future period. It is used to study borrowing, lending, and saving behavior

savings

the part of current disposable income that is not consumed in the current period, If savings is negative, the consumer is borrowing

dissaving

negative saving; this means the consumer is borrowing in the current periof and will pay it back later

real interest saving

The interest rate is measured in terms of goods, not just money. It tells you the trade-off between current future consumption

lifetime budget constraint

the rule showing that the prevent value of lifetime consumption must equal the present value in income minus taxes

present value

the value of income taxes, or consumption that occurs in the future, found by discounting using real interest rates

lifetime wealth

the present value of all income minus the present value of all taxes over the consumers lifetime

endownment point

the point where the consumers simply consumers disposable income in each period and neither borrows near lends

consumption soothing

the tendency of consumers to prefer a smooth path of consumption over time rather than high consumption in one period and very low consumption in another

marginal rate of substitution

the rate at which a consumer is willing to trade current consumption for future consumption while staying equally satisfied

permanent income hypothesis

milton friedmans idea that current consumption depends mostly on a persons long term or permanent income, not just temporary changes in income

temporary change in income

a long-lasting change in income that causes a larger change in current consumption because lifetime wealth rises more

Ricardian Equivalence Theorem

The idea that under certain conditions, changing the timing of taxes doesn’t affect major microeconomic outcomes, because consumers understand that lower taxes today mean higher taxes later

government deficit

When government spending is greater than tax revenue, the government has to borroe

credit market

When government spending is greater than tax revenue, so the government has to borrow