PRINCIPLES OF MACROECONOMICS PART IV Further Macroeconomics Issues TENTH EDITION CASE FAIR OSTER © 2012 Pearson Education, Inc Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly ofTefft 27 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 Household and Firm Behavior in the Macroeconomy: A Further Look* 16 CHAPTER OUTLINE Households: Consumption and Labor Supply Decisions PART IV Further Macroeconomics Issues The Life-Cycle Theory of Consumption The Labor Supply Decision Interest Rate Effects on Consumption Government Effects on Consumption and Labor Supply: Taxes and Transfers A Possible Employment Constraint on Households A Summary of Household Behavior The Household Sector Since 1970 Firms: Investment and Employment Decisions * This chapter is somewhat more advanced, but it contains a lot of interesting information! © 2012 Pearson Education, Inc Publishing as Prentice Hall Expectations and Animal Spirits Excess Labor and Excess Capital Effects Inventory Investment A Summary of Firm Behavior The Firm Sector Since 1970 Productivity and the Business Cycle The Short-Run Relationship Between Output and Unemployment The Size of the Multiplier of 41 Households: Consumption and Labor Supply Decisions The Life-Cycle Theory of Consumption life-cycle theory of consumption A theory of household consumption: Households make lifetime consumption decisions based on their expectations of lifetime income PART IV Further Macroeconomics Issues permanent income The average level of a person’s expected future income stream © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 Households: Consumption and Labor Supply Decisions The Life-Cycle Theory of Consumption PART IV Further Macroeconomics Issues  FIGURE 16.1 LifeCycle Theory of Consumption In their early working years, people consume more than they earn This is also true in the retirement years In between, people save (consume less than they earn) to pay off debts from borrowing and to accumulate savings for retirement © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 PART IV Further Macroeconomics Issues In the life-cycle theory of consumption, a The more income you have, the more consuming you are likely to b High-income households consume a smaller proportion of their income than low-income households c People tend to consume less than they earn during their main working years d All of the above © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 PART IV Further Macroeconomics Issues In the life-cycle theory of consumption, a The more income you have, the more consuming you are likely to b High-income households consume a smaller proportion of their income than low-income households c People tend to consume less than they earn during their main working years d All of the above © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 Households: Consumption and Labor Supply Decisions The Labor Supply Decision Demographics and both legal and illegal immigration play a role in determining the size of the labor force Behavior also plays a role Consumption cannot be considered separately from labor supply because it is precisely by selling your labor that you earn income to pay for your consumption PART IV Further Macroeconomics Issues The Wage Rate A higher wage would lead to a larger quantity of labor supplied—a larger workforce This is called the substitution effect of a wage rate increase If we assume that leisure is a normal good, people with higher income will spend some of it on leisure by working less This is the income effect of a wage rate increase © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 PART IV Further Macroeconomics Issues The data suggest that the substitution effect of a wage increase seems to win over the income effect This means that: a Higher wage rates usually lead to a larger labor supply b Higher wage rates usually lead to a lower labor supply c Higher wages may or may not increase labor supply d There is no relationship between wages and labor supply © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 PART IV Further Macroeconomics Issues The data suggest that the substitution effect of a wage increase seems to win over the income effect This means that: a Higher wage rates usually lead to a larger labor supply b Higher wage rates usually lead to a lower labor supply c Higher wages may or may not increase labor supply d There is no relationship between wages and labor supply © 2012 Pearson Education, Inc Publishing as Prentice Hall 10 of 41 ... Life-Cycle Theory of Consumption life-cycle theory of consumption A theory of household consumption: Households make lifetime consumption decisions based on their expectations of lifetime income... main working years d All of the above © 2012 Pearson Education, Inc Publishing as Prentice Hall of 41 PART IV Further Macroeconomics Issues In the life-cycle theory of consumption, a The more... substitution effect of a wage rate increase If we assume that leisure is a normal good, people with higher income will spend some of it on leisure by working less This is the income effect of a wage rate