Consume today or consume tomorrow?

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Certain cultural goods have a high cost and require either to reduce one’s consumption first in order to save and be able to buy these goods later, or to borrow the missing sum in order to be able to acquire the good immediately, which implies a reduction of its future consumption in order to repay the loan and the associated interest.

For example, the purchase of a television, the preparation of a trip to visit the cultural heritage of a distant country require significant expenses, therefore to finance them over a long period. The budget available to an individual for his consumption in each period may thus differ from his income.

Suppose an agent has an income of €20,000 this year, and expects an identical income next year: he can decide to consume more than his current income this year, by reimbursing the following year, or the reverse, on the contrary, according to his preference for present consumption in relation to the satisfaction provided by future consumption.

A rational agent therefore maximizes his satisfaction over several periods by making intertemporal consumption choices, depending on the income expected at each period, the evolution of prices, and the interest rates which influence the decision to borrow or ‘save.

When we reason over several periods, we consider that the consumer faces an intertemporal budget constraint. He determines the budget he will devote to consumption for each period, taking into account the consequences of his choices on the following periods.

Thus, the consumer integrates the fact that if he saves, he will be able to consume more in the future because his savings can be invested.

The choice between consumption and saving varies throughout life, and the life cycle model proposed by F. Modigliani (1918-2003) is based on the idea that individuals seek to smooth their consumption over the course of their lifetime. existence, while their income varies greatly according to age.

In order to experience a steady increase in their standard of living, they must borrow and save differently depending on the period.

In the document below, we see that during the period of youth, the desired consumption is higher than the income (zone A on the graph), and the households have to borrow what reduces their net wealth, the latter being the difference between the assets held by households (financial products, real estate, valuables, etc.) and their debts.

Document: Income, Consumption and Wealth in the Life Cycle Model

Consume today or consume tomorrow?

Households can then rebuild positive savings (zone B) during their period of activity, which makes it possible to repay debts and then build wealth, which can be used during retirement to compensate for the loss of income. (area C). The three curves of income, consumption and net wealth are therefore linked, and the savings rate, understood as the
relationship between savings and income, changes throughout life.

Note that if the value of wealth increases due to a rise in the price of an asset, this offers new consumption possibilities to households who can use this enrichment to consume more.

Some cultural products themselves have heritage value: paintings and works of art can increase in value over time, they are not “consumed” when they are acquired.

Households therefore have the possibility of acquiring cultural goods for heritage purposes, but empirical studies show that, in general, the profitability of the purchase of works of art is lower than that of financial assets.

It must therefore be assumed that individuals buy works of art to derive more aesthetic than financial satisfaction from them, or that they misjudge the evolution of asset prices (bias in the perception of inflation, for example).

The life cycle model makes it possible to understand why the average age of a population has an impact on its savings behavior, but it remains very summary because it does not take into account the vagaries that can affect income over time. , and household adaptation.

The latter are supposed to know perfectly the evolution of their income. Mr. Friedman has laid the foundations of a new consumer theory, which gives an important place to household expectations: we do not spend in the same way an income perceived as “transitory” and what he calls permanent income, that is to say the part of the income on which the household thinks it can count in a sustainable way.

Mr. Friedman considers that permanent income determines the consumption of agents in a stable manner, and depends not only on income from activity, but on all the wealth on which they can count (heritage, human capital, etc.).

This approach and the resulting Keynesian debates have played a big role in macroeconomics. At the microeconomic level, this makes it possible to emphasize the importance of expectations, and of the perception by households of the stability of their income in the decision to consume.

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