Question

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? a. A large decrease in real estate values, including private homes. b. A sharp, sustained increase in stock prices. c. A 5 -year increase in the minimum age for collecting Social Security benefits. d. An economy-wide expectation that a recession is over and that a robust expansion will occur. e. A substantial increase in household borrowing to finance auto purchases.

Short answer

Decreases in real estate values and delayed Social Security shift consumption down; increases in stock prices, positive economic outlooks, and more borrowing shift it up.

Step-by-step solution

Analyzing Decrease in Real Estate Values

If real estate values decrease significantly, households may feel less wealthy and secure. This typically leads to a decrease in consumption as people may want to save more due to concerns about their net worth. Consequently, the consumption schedule would shift downward, and the saving schedule would shift upward.

Impact of Increase in Stock Prices

A sharp increase in stock prices often increases household wealth, making people feel richer. This could encourage more spending as people feel that their future financial situation is more secure. Thus, the consumption schedule would shift upward, and the saving schedule would shift downward.

Effect of Delayed Social Security Benefits

An increase in the age for collecting Social Security benefits means people will possibly need to save more for retirement. This expectation of needing more self-funded retirement will likely increase saving in the present, shifting the saving schedule upward and the consumption schedule downward.

Expectation of Economic Expansion

When households expect that a recession is ending and a strong economic expansion is likely, they may be more willing to spend due to increased economic optimism. Hence, the consumption schedule would shift upward, and the saving schedule would shift downward as households rely less on saving for future uncertainties.

Increase in Household Borrowing

With increased borrowing, particularly for durable goods like autos, immediate consumption increases due to the availability of credit. This shifts the consumption schedule upward. However, this might not significantly affect the saving schedule immediately, as future income is expected to cover the borrowed amounts.

Key concepts

The Wealth Effect

The wealth effect refers to how changes in perceived wealth can impact consumption and saving behaviors. For example, when assets like real estate or stocks go up in value, people feel wealthier and may spend more, thus increasing the consumption schedule. They might feel financially secure and reduce their savings rate. Conversely, when asset values drop, as with a decrease in real estate prices, people may feel poorer and spend less, increasing savings as they try to protect their net worth. This shift in saving and spending patterns relative to perceived wealth is a crucial concept in understanding economic behavior.

Economic Expectations

Economic expectations play a major role in household financial decisions. When people anticipate a positive economic future, such as the end of a recession and beginning of expansion, they are more likely to increase their consumption. This optimism leads to a shift upwards in the consumption schedule as consumers spend in the anticipation of better financial times ahead. On the other hand, if there are fears of an economic downturn, people may become more conservative, saving more and spending less, altering saving and consumption schedules accordingly.

Retirement Planning

Retirement planning is significantly affected by policies that alter retirement benefits. For instance, increasing the age for Social Security benefits forces individuals to reconsider their long-term saving strategies. People might increase their current savings to cover a potentially longer period before those benefits kick in. This necessity to save more for retirement leads to an upward shift in the saving schedule and a potential decrease in current consumption as funds are reallocated to savings.

Household Borrowing

Household borrowing, especially for significant purchases like automobiles, can boost consumption in the short term. When borrowing increases, people have increased access to credit, which allows them to make purchases they might have delayed otherwise. This leads to an upward shift in the consumption schedule. In the long run, however, the impact on savings might vary. Households might anticipate paying off this borrowing from future income, thus not significantly adjusting their savings unless they face pressures in meeting their debt obligations.

Asset Valuation

Asset valuation impacts household wealth perception and, consequently, consumption and saving behaviors. When asset values such as stock prices see a sharp rise, households often feel richer, potentially spurring increased spending and reducing the savings rate as they expect their financial situation to be stable or improving. This results in a shift upward in the consumption schedule and downward in the saving schedule. Understanding how the valuation of assets affects economic decision-making is vital for both households and policymakers aiming to predict and manage economic trends.