Consumption pattern The application of Life Cycle Hypothesis

He compared and studied housing and non-housing goods with the modification to simple life cycle hypothesis which can more resemble the consumption patterns of US. He stated that an individual occupies house due two main reasons: it can be used as a utility and also can be used as collateral. The modified framework he came up with had some frictions in it which were to be faced by the households: income risks; borrowing constrains; lack of an annuity market to insure against an uncertain lifetime; and transaction costs of trading houses. He claims that household save to self-insure and to enjoy services from housing. He gathered consumption data and asset data to construct synthetic cohorts from each data set. In the model he has taken some main dependent variables Technology and timing; The rental market; Demographics; Consumer’s maximization problem; Transaction costs; and Borrowing constraints. The Numerical results studies the implications of the model economy for homeownership rates by age and for the life-cycle consumption and wealth profiles for both homeowners and renters.

Government debt and social security in a life-cycle economy. They also examine whether considerations of life-cycle and demographic structure alter the dynamic properties of the monetary business cycle model, specifically the degree of amplification in impulse responses. Bean (2004) summarizes the previous findings in this field, pointing out their implications for a central bank:

1) demographic developments represent a macroeconomic shock, which may lead to abrupt movements in asset prices and sharp movements in saving behavior.

2)the natural rate of interest falls both along the transition path and in the steady state.

3) the natural rate of unemployment may also be affected through the matching mechanism5.

4) the wealth channel is likely to become a more important transmission channel of monetary policy than intertemporal substitution.

5) the Phillips curve is flatter due to immigration and the increased participation of retired workers whose supply of labor is considered to be relatively elastic.

6) the constituency for keeping inflation low will be larger thanks to higher average wealth accumulation.

7) societal aging may induce diversification and risk-shifting with a securitized market rather than bank-intermediated finance, which has implications for financial stability.

The model they used is canonical model, with the main variables of Firms, Capital producers, Financial intermediaries, households and monetary policies. The sub variables and intervening variables are also discussed in detail. Paper concluded that First, the natural rate of interest differs as demographics change. Second, the structural shocks to the economy have asymmetric effects on heterogeneous agents, namely workers and retirees.

They documented that household age-consumption profiles, adjusted for both economic growth and family size, have a distinct and statistically significant hump, with actual consumption on the increase during ages 20-40 and falling off during ages 50-70. Paper has also done a quantitative analysis on US data of households. They concluded that taking account of the effects of consumption leisure substitutability in household preferences may help explain the life cycle consumption data that has been viewed as puzzling.

The behavioral life-cycle model as developed by Shefrin and Thaler is a simple model of self-control based on three ideas. First, individuals are tempted to spend all their resources on current consumption instead of saving for the future. Second, individuals who save, overcome this self-control problem by investing in a variety of assets that have different levels of temptation associated with them. Third, setting up these mental accounts implies that individuals engage in `framing’ a person’s consumption spending not only depends on total wealth but also depends on how that wealth is allocated among assets with differing levels of `temptation’. For example, individuals are more willing to spend assets they have labeled current income than those they have labeled wealth or those that they expect in the future. This paper has four major results. First, spending seems to be very sensitive to changes in income but much less sensitive to changes in wealth. Second, close examination of the relation of wealth to consumption reveals a pattern in which individuals treat assets as not being fungible (equivalent to each other). Third, liquidity constraints affect consumption not as the conventional model predicts but in a manner consistent with the existence of either financial or psychological transaction costs. The affect of these constraints may also be evidence of a behavioral bequest motive. Finally, the amount spent on particular goods seems to depend not only on the individual’s total resources but also on how those resources are split between different assets.

The paper concluded that the empirical life cycle consumption profile in the US has a hump that peaks around age 50. This is typically considered a puzzle since the complete markets life cycle model would produce a consumption profile that is monotonic over the life cycle.

The results obtained in this paper and they show that there is a discontinuity between the characterization of the finite horizon optimal solution and of the infinite horizon optimal one.

Our main analytical result is a necessary and sufficient condition under which any degree of overconfidence concerning the mean return on savings can produce a hump in the work-life consumption profile. There instinct is that consumer overconfidence may not only have important implications for trading and asset prices, but for consumption as well. We thus study the implications of consumer overconfidence in a general life-cycle consumption/saving model. The paper has have shown that overconfidence concerning the mean return on savings can produce a work-life consumption hump while overconfidence about the variance of the return has little effect on the long-run average behavior of consumption over the life cycle, and that our basic conclusion is fairly robust with various realistic modifications to the baseline model.

They concluded that our survey evidence on faculty pay-cycle choice strongly contradicts the neoclassical theory of consumer behavior. It is more favorable to the behavioral life-cycle theory of Shefrin and Thaler (1988).

The paper has studied the patterns of individuals saving and consumption in relation inflation. Paper concluded that in the past there have been times when consumers with differing price expectations did not differ in their rate of discretionary spending; while there have been other times when perceptions of price advances led to a reduction in the rate of consumer spending.