People tend to try and predict what their future needs will be in order for them to be able to satisfy their current and future wants. The two-period model of intertemporal choice tries to interpret based on the current time period (e.g. this month) and a prediction of the future time period (e.g. next month) what consumers will be able to spend, borrow or save according to their levels of income and interest rates. In this assignment however we are mostly concerned on the changes of interest rate and specifically the impact an increase in the level of interest rates would have to consumers who are either savers or borrowers in the first period and how would that affect their consumption levels.
Generally it is well known in economics that purchasers always want to maximize their utility levels. The maximum utility is given by the formulae of max U = f(C, C’) being subject to the equation of future consumption {[Y – C](1+r) + W = C’ – Y’} . This is an important part for our assumptions since a customer would have problem determining his/her maximum utility for present as well as future consumption when faced with a certain lifetime budget constraint. The budget line represents the levels of consumption for both periods according to some factors such as present and future income as well as the interest rate level and has a slope of –(1+r ). Before considering the effects of a change in the interest rates it is important to understand the first step of the consumption model. In the diagrams A and B below, we can understand that (I) the indifference curves, act on behalf of the equal levels of utility satisfaction derived from different mixtures of present and future consumption. That being said the point (W), which is identified a...
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...come worse off. That is due to the reason that an increase in the level of interest rate leads to a relatively smaller current consumption, since borrowing from the future is not the ideal solution because it has become more expensive than before. Generally for a borrower current consumption always falls while savings rise.
To conclude, I believe it is understandable by now that for a consumer who is a saver in the first period has not become worse off and in some occasions where the income effect exceeds the substitution effect has become better off. On the other hand a borrower in the first period has definitely become worse off than before.
Works Cited
http://www.digitaleconomist.org/tpc_4020.html http://www.uam.es/personal_pdi/economicas/mjansen/teaching/dynamicmacroenglish/lecture3_en_2012.pdf http://pioneer.netserv.chula.ac.th/~tsaksit/micro2/lecture2_1.pdf
When interest rates on loans are high, this leaves people with less disposable income resulting in less consumer spending. Depending on where the economy stands, this can be good or bad, as it would lead toward recession. But that may be exactly what is intended in order to decrease spending if the economy is currently experiencing over-inflation. The government may intentionally send the market into a recession rather than potentially risking too high levels of inflation. On the other hand, if the economy were already in recession this would only make the recession worse. In the situation where the economy is currently in recession, the government is instead going to change the overnight rate in order to therefore lower interest rates on loans in order to provoke consumer
the business needs to make up the costs and the only way to do this is
...roportionally higher taxes and come of welfare benefits, moderating the disposable income. As incomes fall in a recession the impact the falling incomes have for income earners is softened as high income earners pay less tax proportionally, and retain more post-tax income, while the low income earners receive benefits, thus injecting into the economy and moderating a downturn in the economy, this is fiscal boost.
The Federal Reserve was created by Congress on December 23, 1913. The current chairperson for the Federal Reserve is chairman Jerome Powell. The Federal Reserve was created to provide a federally insured system. All banks that are FDIC insured have to fall under the Federal Reserve. The Federal Reserve regulates the banks and creates a safer environment for their customers. The Federal Reserve affects the U.S. has been affecting the U.S. economy ever since it was established. It’s system promotes maximum employment and initiate stable prices for goods and services. It intends to also bring stability and balance to the financial system. The Federal Reserve also decides the federal interest, which has the power to dramatically affect the economy
incomes by the same, the people who receive this increase will spend some and save
If the rate is set at 2 percent, the demand from reliable consumers will be 40 and the demand from unreliable consumers will also be 40. However, we must remember that due to the unreliable borrowers, and the corresponding risk of default, the interest rate is 24% not 2%. That means that demand among reliable consumers is -5.8 and none will borrow while demand is still 40 for unreliable borrowers who will all borrow. The reason why unreliable consumer demand is unrelated to rate prices is because they are unreliable and do not intend to make payments in the first
Mian and Sufi stated a variety of problems in “House of Debt”. First, they noted that data on credit spreads suggest that the financial system was fully repaired by late 2009, and that even though the economy at that point was very depressed, growth had been feeble since. Second, they observed that spending on housing and durable goods such as furniture and cars decreased sharply in 2006 and 2007, well before any financial
When decisions bases on a consumers finances have following consequences further than the near future, then an individuals' success economically could depend on the ability they have to foresee the upcoming rate of inflation. according to statistics, higher expectations for inflation were reported by females who were poorer, they were single and they were less educated. More specifically, higher expectations for inflation were reported by people who focused more-so with how they can cover future purchases and expenses and the prices they will pay, and by ones who have lower knowledge on financial literacy.
Rashid, Muhammad; Mitra, Devashis, Price Elasticity of Demand and an Optimal Cash Discount Rate in Credit Policy, Financial Review, Aug99, Vol. 34 Issue.
Consumption is one of the basic needs of the human being. Where economic is the social science in which we study how to fulfill our basic needs with unlimited desires and scarce resources. These days’ major issue of generally any economy and particularly Pakistan economy is printing of lot of money i.e. increase in money supply. Now the question is how this increase in money supply affects the consumption expenditure in Pakistan? To get the answer of this question many scholars and authors such as Mushtaq, Ghafoor, Abedullah and Ahmed (2011), Choudhry and Noor (2009) and Zakaria (2007) examine the impact of money supply growth on consumption expenditure and found positive relationship between the both. Empirical studies by scholars like Mthuli Ncube and Eliphas Ndou (2011) have shown that there is no direct impact of money supply on consumption expenditure rather it effects the spending of consumer indirectly. Consumption can be changed due to change in interest rate i.e. initially change due to change in money supply. There are two ways through which interest rate can effect consumption expenditure one is direct and other is indirect way. Direct method shows direct impact of interest rate on consumption. The indirect method further operates in two ways. First change in interest rate has strong impact on demand of housing it means it will affect prices of housing so that shows change in wealth of household. In second steps that further lead to decrease in the consumption expenditure of people. The direct effect shows that increase in interest rate has income ...
One important incentive for saving is interest or return on your investments, i.e. that you will be able to spend more tomorrow if you save today. The earlier you start saving and investing, the more interest you will accrue and thus the earlier you should achieve financial freedom. An important turning point will be if you have saved enough to avoid any consumer credits. Your interest on these savings will be the avoided interest on your consumer credits and in addition, what you receive on your savings account while saving.
One of the important economic variables being tracked is the consumer price index released by the Conference Board every month. Lately, people have claimed the economy seems to have a fair projection for consumer spending to some extent based on a 3.2 index increase in the last report. More specifically, thanks to the recent spending of the top 15% households comprised by higher income families, according to the report made by Kathleen Madigan of the Wall Street Journal in the article "Vital Signs: The 15%ers Are Feeling Better — and That’s Good for Economy’. However, the article and the chart posted note an important observation regarding the study of this trend. In 2012, the Commerce Department data implied the economy would suffer as high-income consumers felt nervous about the state of the economy generating a cutback in spending. Nevertheless, the trends seems to be different nowadays given that the economy is reacting to a new financial atmosphere in a new season. The data presented by Commerce notes wealthier families have decreased their spe...
Interest rates and the effects of interest rates on the economy concern not only macroeconomists but consumers, savers, borrowers, and lenders. A country may react and change their interest rates, according to the prosperity of their economy. Interest rates, is the percentage usually on an annual basis that is paid by the borrower to the lender for a loan of money (Merriam-Webster). If banks decided not to use interest rates, it would be impossible for others to be able to take out loans and therefore, there would be far less spending money in the economy. With interest rates, this allows banks to take a percentage of the consumer’s money and loan it out to others, thus allowing economic growth to be possible. Interest rates also allow lenders to have a “safety net” which is necessary because there is a possibility that the borrower would be unable to pay back a loan to the bank. A nation’s interest rates can be raised or lowered and these shifts in interest rates correlate directly to aggregate demand. Aggregate demand, is the total demand for final goods and services in an economy at a given time (Business Dictionary). A nation uses interest rates for economic growth or to help prevent inflation. When economic growth is needed a nation would lower their interest rates. However, if a country is concerned about inflation, they may choose to raise their interest rates. When interest rates, raised or lowered, will have a negative or positive impact on consumers, and have a positive or negative impact on investors.
Distinguish clearly between the Income and the Substitution Effects of a change in the Price of a Good. Under what Conditions will the Income Effect and the Substitution Effect act in Opposite Directions?
According to the four-way equivalence model, both interest rates and inflation rates are theoretically associated with expected changes in spot rates. Your task is to review the empirical evidence relating to this assertion and determine whether these theoretical relationships have any basis in fact.