DP

The forward looking consumer in the time of co-vid 19

By meekel • 7 months ago • 12964 • 4810
The forward looking consumer in the time of co-vid 19

"While I thought that I was learning how to live, I have been learning how to die."

   Basically, the spending decisions of rational agents in the present are influenced by their expectations of the future. Thus, there is an intertemporal component to consumption.

Generally, people's income fluctuates over their life cycle; it also fluctuates when they lose their job, move to a different job or get a promotion.

   Hence, given that people prefer to smooth out the fluctuations in their income on their spending behaviour (known as consumption smoothing), they must take account of the future and they must be able to save and borrow. 

 In economic theorizing, the desire to smooth consumption in the face of fluctuations in income is captured by the assumption of diminishing marginal utility of consumption.

  A simple way of visualizing this is to consider the choice of consumption in a world of just two periods. 

  Suppose that the first period is the current period which is the period of Covid-19 and the second period is the next period which is the period after covid-19.

   Given that in the current period of Covid-19, everyone is indoors and there is no income; also, given the irrevocable knowledge that in the next period after Covid-19 there will be high income, how does that affect Consumption now? 

Consider the choice between either low consumption equal to low income (or zero consumption equal to zero income) in the current period and high consumption equal to high income in the next period, or having the average of the two consumption levels in each period.

   Specifically, if there is diminishing marginal utility of consumption, more consumption always increases utility, but successive increases in consumption deliver smaller and smaller benefits.

Therefore, given the above, rational households (or consumers) will make the second choice, because consuming the average in both periods offers higher utility than the first choice. 

Conclusively, in the current period of Covid-19 in which households find themselves, they must be willing to do one of two mutually exclusive things; they must be willing to run down their past savings or they must be willing to dis-save (for the later, there is no such thing as borrowing in economics).

These are not psychological contemplations, these are economic postulations that hold and will continue to hold even in this time and in time to come.



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