Answer to Question #172968 in Macroeconomics for Landlord

Question

Use fishers model of consumption to analyze the increase in second period income. Compare the case in which the consumer faces a binding borrowing constraint and the case in which he does not

Answer 1

This model is associated with identifying the rules of behavior of households as subjects of the economy in relation to making decisions about current and future consumption. As we have already noted, the main constraint on consumption is the level of income. It is called the budget constraint. When deciding what share of consumption in current income should be discarded in order to maximize future consumption, it is necessary to take into account the intertemporal budget constraint.

Fisher considered consumption in two time periods: youth and old age. In the first period, the consumer has income I1, and the consumption volume is C1. In the second time period I2 - and C2, respectively. It should be noted that all variables are measured by real values, i.e. adjusted for inflation.

Since consumers can lend and borrow (live in debt) themselves during both periods, it does not matter how much is consumed in each period of time.

The only important thing is that future income is discounted at the real interest rate. This means that consumption depends both on: the present value of income in a certain period, and on the present value of future income.