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Consumption, Saving, and the Supply of Loanable Funds

Consumption

Consumption is a function of income and, possibly, the interest rate.  The marginal propensity to consume is often assumed to be close to, but less than one.

Savings

Savings is an increasing function of income and, possible, the interest rate.  S(Y,R).

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Analysis

The EconModel presentation shows that savings results from intertemporal substitution.  In this generalization of the Two Goods - Two Prices Model, agents maximize utility over two goods:  consumption in the present and consumption in the future.  The interest rate plays the role of the relative price of these two options.

Budget Constraint

Indifference Curves

The Interest Rate

Permanent Income Hypothesis

An alternative view.

References

Intertemporal Consumption, Wikipedia.

Permanent Income Hypothesis, Wikipedia.


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