Undergraduate Course: Consumption and Saving: Where Micro Behaviour Meets Macroeconomic Policy (ECNM10125)
Course Outline
| School | School of Economics |
College | College of Arts, Humanities and Social Sciences |
| Credit level (Normal year taken) | SCQF Level 10 (Year 3 Undergraduate) |
Availability | Available to all students |
| SCQF Credits | 20 |
ECTS Credits | 10 |
| Summary | Why do some people spend a windfall immediately while others save every penny, and why does getting this right matter for the success or failure of government policy? This Honours course takes students from the foundational models of consumption and saving, including the Permanent Income Hypothesis and lifecycle models, through overlapping-generations frameworks that unpack the economics of pensions and intergenerational transfers, all the way to the research frontier of heterogeneous-agent economies where households face uninsurable income risk, liquidity constraints, and incomplete markets. Realworld policy episodes, notably the U.S. stimulus payments of 2001 and 2008, serve as quasi-natural experiments for estimating how different households actually respond to income shocks, while the final part of the course explores how heterogeneity extends from households to the goods they buy, including price dispersion, consumption baskets, and exposure to trade shocks. Hands-on tutorials in R offer the opportunity to simulate models, run Monte Carlo exercises, replicate published empirical results, and estimate heterogeneous consumption responses first-hand; no prior programming experience is assumed. |
| Course description |
Part I ¿ The Representative-Agent Benchmark
We begin with the representative-agent paradigm to establish the theoretical benchmark against which richer models will be evaluated.
1. The Two-Period Consumption¿Saving Model. This lecture introduces intertemporal optimisation as the foundational tool for analysing consumption decisions.
2. The Permanent Income Hypothesis. We develop the PIH as a forwardlooking alternative to the Keynesian consumption function.
3. Rational Expectations and Testable Implications. We show how the PIH generates empirically testable restrictions when embedded in a stochastic rational expectations framework. We interpret Hall's model through Sargent's conception of an economic model as a stochastic process.
4. The Lifecycle Model. We extend the benchmark to finite horizons to analyse retirement and wealth decumulation.
Part II ¿ Intergenerational Structure and Pension Systems
We move beyond a single representative household to analyse intergenerational interactions and the economic logic of pension systems.
5. The Overlapping Generations Model. This lecture introduces an economy with multiple cohorts coexisting in time.
6. Dynamic Inefficiency and Double Infinities. We examine how OLG models can generate inefficient equilibria and intergenerational welfare trade-offs.
7. Public Pensions and Longevity Insurance. We interpret public pensions as longevity insurance and compare PAYG and funded systems as alternative financing mechanisms.
Part III ¿ From Representative Agent to Heterogeneous Households
We relax the representative-agent assumption and introduce idiosyncratic income risk, liquidity constraints, and heterogeneity in marginal propensities to consume.
8. Income Risk and Certainty Equivalence. We analyse consumption behaviour under uncertainty when precautionary motives are absent.
9. Liquidity Constraints. We introduce borrowing limits and show how they generate excess sensitivity to income shocks.
10. Precautionary Saving. We demonstrate how convex marginal utility generates precautionary motives and wealth accumulation.
11. Buffer-Stock Behaviour and Incomplete Markets. We study target-wealth behaviour and wealth dispersion in incomplete-markets economies.
12. Wealthy Hand-to-Mouth Households. We reconcile high wealth with high marginal propensities to consume in heterogeneous-agent models.
Part IV ¿ Household Heterogeneity and Economic Stimulus
We examine how real-world fiscal stimulus programs interact with household heterogeneity and how quasi-natural experiments allow us to identify marginal propensities to consume.
13. Institutional Design of Economic Stimulus Payments. We analyse the structure and timing of the 2001 and 2008 stimulus programs and how policy implementation generates plausibly exogenous income variation.
14. Natural Experiments and the Measurement of MPCs. We use stimulus payments as quasi-natural experiments to identify heterogeneous marginal propensities to consume.
Part V ¿ Prices, Lifecycle Behaviour, and the Retirement Puzzle
We enrich the framework by incorporating price dispersion, shopping behaviour, and retirement dynamics.
15. Lifecycle Prices. We show how shopping intensity and price dispersion vary systematically over the lifecycle.
16. The Retirement Consumption Puzzle. We examine the decline in expenditure at retirement and its interpretation through home production.
17. Price Dispersion and Search. We introduce search frictions as a source of equilibrium price dispersion.
Part VI ¿ Heterogeneous Goods in Modern Macroeconomics
We conclude by examining recent macroeconomic research that explicitly models heterogeneous consumption goods and differential exposure to price changes.
18. Spatial Price Dispersion and Consumption Baskets. We analyse how local price variation shapes household welfare and inequality.
19. Trade, Relative Prices, and Household Exposure. We study how international trade shocks affect households differently through their consumption baskets.
20. Durable Goods, Policy, and Macroeconomic Transmission. We introduce durable consumption as a distinct margin of adjustment with lumpy investment and resale value. We show how durable goods modify the random walk implication of the Permanent Income Hypothesis and amplify the transmission of fiscal and monetary policy. We analyse scrappage subsidies and targeted interventions in durable goods markets.
21. From Heterogeneous Households to Heterogeneous Goods. We integrate household heterogeneity and goods-level heterogeneity to evaluate macroeconomic policy design.
Tutorials (6 × 1 Hour)
1. R and Intertemporal Simulation. We simulate the two-period model and build foundational programming skills.
2. Monte Carlo Simulation and Income Risk. We simulate stochastic income processes and evaluate estimation uncertainty.
3. Economic Stimulus Payments as Natural Experiments. We replicate the identification logic of the 2008 ESPs to estimate average MPCs.
4. Heterogeneous MPCs and Quantile Regression. We estimate distributional responses and interpret quantile treatment effects.
5. Simulating Buffer-Stock Behaviour. We simulate precautionary saving and target-wealth dynamics in incomplete-markets settings.
6. Simulation of Heterogeneous Goods. We simulate goods-level heterogeneity and study aggregation to macro outcomes.
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Information for Visiting Students
| Pre-requisites | None |
Course Delivery Information
| Not being delivered |
Learning Outcomes
On completion of this course, the student will be able to:
- Analyse and empirically evaluate intertemporal consumption behaviour using micro-founded models in order to assess the design and distributional effects of macroeconomic and fiscal policy.
- Demonstrate research and investigative skills such as problem framing and solving, as well as the ability to assemble and evaluate complex evidence and arguments.
- Demonstrate communication skills in order to critique, create and communicate understanding.
- Demonstrate personal effectiveness through task management, time management, dealing with uncertainty, adapting to new situations, and personal and intellectual autonomy through independent learning.
- Demonstrate practical/technical skills such as modelling skills (abstraction, logic, succinctness), qualitative and quantitative analysis.
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Reading List
1. Adda, J., & Cooper, R. (2000). Balladurette and juppette: A discrete analysis of scrapping subsidies. Journal of Political Economy, 108(4), 778¿806.
2. Aguiar, M. and E. Hurst (2005). Consumption versus expenditure. Journal of Political Economy, 113(5), 919¿948.
3. Aguiar, M. and E. Hurst (2007). Life-cycle prices and production. American Economic Review, 97(5), 1533¿1559.
4. Burdett, K. and K. L. Judd (1983). Equilibrium price dispersion. Econometrica, 51(4), 955¿969.
5. Carroll, C. D. (1997). Buffer-stock saving and the life cycle/permanent income hypothesis. Quarterly Journal of Economics, 112(1), 1¿55.
6. Diamond, P. A. (1965). National debt in a neoclassical growth model. American Economic Review, 55(5), 1126¿1150.
7. Friedman, M. (1957). A Theory of the Consumption Function. Princeton University Press, Princeton, NJ.
8. Grolemund, G. (2014). Hands-On Programming with R. O¿Reilly Media, Sebastopol, CA.
9. Hall, R. E. (1978). Stochastic implications of the life cycle¿permanent income hypothesis: Theory and evidence. Journal of Political Economy, 86(6), 971¿987.
10. Handbury, J. (2021). Are poor cities cheap for everyone? Non-homotheticity and the cost of living across U.S. cities. Econometrica, 89(6), 2679¿2715.
11. Huggett, M. (1993). The risk-free rate in heterogeneous-agent incomplete-insurance economies. Journal of Economic Dynamics and Control, 17(5¿6), 953¿969.
12. Jappelli, T. and L. Pistaferri (2017). The Economics of Consumption: Theory and Evidence. Oxford University Press, Oxford.
13. Kaplan, G., G. L. Violante, and J. Weidner (2014). The wealthy hand-to-mouth. Brookings Papers on Economic Activity, 2014(1), 77¿138.
14. Mankiw, N. G. (1982). Hall¿s consumption hypothesis and durable goods. Journal of Political Economy, 90(3), 615¿623.
15. Modigliani, F. and R. Brumberg (1954). Utility analysis and the consumption function: An interpretation of cross-section data. In K. K. Kurihara (ed.), Post-Keynesian Economics, pp. 388¿436. Rutgers University Press, New Brunswick, NJ.
16. Neiman, B. and J. Vavra (2023). The rise of niche consumption. American Economic Journal: Macroeconomics, 15(3), 224¿264.
17. Orchard, J. D., Ramey, V. A., & Wieland, J. F. (2025). Micro MPCs and macro counterfactuals: The case of the 2008 rebates. Quarterly Journal of Economics, 140(3), 2001¿2052.
18. Parker, J. A., N. S. Souleles, D. S. Johnson, and R. McClelland (2013). Consumer spending and the economic stimulus payments of 2008. American Economic Review, 103(6), 2530¿2553.
19. Pytka, K. ® D. Runge (2025). Looking into the consumption black box: Evidence from scanner data. Working Paper.
20. Sargent, T. J. (1987). Macroeconomic Theory. 2nd ed. Academic Press, New York.
21. Shell, K. (1971). Notes on the economics of infinity. Journal of Political Economy, 79(5), 1002¿1011. |
Additional Information
| Graduate Attributes and Skills |
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| Keywords | Not entered |
Contacts
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Course secretary | |
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