Macroeconomists tend to use a simplified version of the optimization framework called the “ permanent income hypothesis,” whose origins trace back to economist Milton Friedman’s treatise A Theory of the Consumption Function (1957). Life-cycle models are most commonly employed by microeconomists modeling household-level data on consumption, income, or wealth. The standard version of the life-cycle model also assumes that consumers would prefer to spend everything before they die (i.e., it assumes there is no bequest motive). The “ life-cycle” model, first articulated in “ Utility Analysis and the Consumption Function” (1954) by economists Franco Modigliani and Richard Brumberg, proposes that households’ spending decisions are driven by household members’ assessments of expenditure needs and income over the remainder of their lives, taking into account predictable events such as a precipitous drop in income at retirement. Within the rational optimization framework, there are two main approaches. In the interest of simplicity, the standard versions of these models also make some less-innocuous assumptions, including assertions that the pleasure yielded by today’s consumption does not depend upon on one’s past consumption (there are no habits from the past that influence today’s consumption) and that current pleasure does not depend upon comparison of one’s consumption to the consumption of others (there is no “envy”). For example, economists usually assume (1) that the urgency of consumption needs will decline as the level of consumption increases (this is known as a declining marginal utility of consumption), (2) that people prefer to face less rather than more risk in their consumption (people are risk-averse), and (3) that unavoidable uncertainty in future income generates some degree of precautionary saving. This “rational optimization” assumption is untestable, however, without additional assumptions about why and how consumers care about their level of consumption therefore consumers’ preferences are assumed to be captured by a utility function. In their studies of consumption, economists generally draw upon a common theoretical framework by assuming that consumers base their expenditures on a rational and informed assessment of their current and future economic circumstances. SpaceNext50 Britannica presents SpaceNext50, From the race to the Moon to space stewardship, we explore a wide range of subjects that feed our curiosity about space!Ĭonsumption theory The rational optimization framework.
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CONSUMPTION ECONOMICS HOW TO
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