Consumption - 2

ECN 201 -Economic Data Analysis

Lawlor

Review

• Linear form of consumption function:– C = a + b*Y

– where a is “autonomous spending”– b = MPC

– Fits Keynes’s “Fundamental Psychological Law”

– Fits the U. S. post-war data: Gretl• LR MPC = .96

– Fits the U. S. Great Depression• MPC = .76

Further Explore The MPC

APC = the Average Propensity to Consume– = C/Y = (a + by)/Y = a/y + b

• Define MPC and APC graphically

• Show how to simulate it on Excell

Explore meaning of “a”

• Statistically is the measure of our ignorance• Algebraically, Graphically a’s arithmetic sign

related to the rate of change of APC while income changes– If it is negative, a/Y<MPC, APC <MPC, and falls as

income rises– If it is positive, a/Y>MPC, APC>MPC, and rises as

income rises– If it is zero, a/Y = MPC, APC = MPC, and is constant

as income rises

Can Simulate this with Excel• Decide on the parameters “a” and “b”

• Fill in different values of Y to get different values of C

• Show on Excel

Does the l.r. Cons. Fn. Make Sense

• Remember in Keynes’s discussion of “units” he said aggregate variables were only comparable over the s. r.– Meant aggregate Y, C, P

• We may want to restrict our comparisons to “decade” long units at the most– We ask you to do some of this type of

modeling in Gretl in your assignment - show

Or, both in the s.r. and the l.r. may want to add more variables

• Keynes mentioned “windfall changes in capital values”

• Perhaps the way Americans, and American society, has altered the way that average people save, and so changed the average household balance sheet, has effected the MPS

• Discuss this, and the difference between “defined benefit” plans and “defined contribution plans”

What sorts of assets are important to Households

• Mutual Fund saving suggest that financial market instruments might be important– Could proxy this effect statistically with stocks

• See the St. Louis Fed database

• The Current period suggest some people are saving through speculation in housing

Note relation to cons. Fn.

• We are saying there is more than one variable responsible for a con. fn, and so a savings fn.– C = f(Y, stock values, house values, culture,

financial market innovation (sub-prime mortgages))

– Statistically, this increase in rhs variables means we are entering into the realm of “multiple variable regression”

One linear form of this

• C = a + b1Y + b2S&P500

• Note we are asking you to explore this possibility in the LR in your project

• Look at TRSP in Gretl, graph it as a time series, explain its dynamics

• Explore time series plot alone and with C, with APC• Show how to construct APC

• Class example might be to consider a recent s.r. period: – Note: first consider data availability, what we know of institutional

and economic history

• TRSP Limits us to 2003:12, so lets run a regression for the period 1983:12 – 1993:12– Captures the period of run up in stock values

• Show how in Gretl “range” and “model”

• Model the cons. fn. for this period with and without TRSP