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Short-term planning and the life-cycle consumption puzzle

  • Frank Caliendo

    (Northern Arizona University)

  • David Aadland

    (University of Wyoming)

This paper provides a new explanation for the hump-shaped age- consumption profile observed in household data. Standard life-cycle models are based on an optimization problem that spans the entire life expectancy. Alternatively, we examine the consumption profile of an individual with a shorter planning horizon. The actual consumption profile is the envelope of a continuum of control problems because the agent’s short-term planning horizon continually slides along the time- scale, and the agent is therefore continually re-optimizing. We derive analytical solutions to a deterministic, continuous-time control model with this characteristic and we show that hump-shaped consumption is a feature of the model.

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File URL: http://econwpa.repec.org/eps/mic/papers/0404/0404003.pdf
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Paper provided by EconWPA in its series Microeconomics with number 0404003.

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Length: 16 pages
Date of creation: 07 Apr 2004
Date of revision:
Handle: RePEc:wpa:wuwpmi:0404003
Note: Type of Document - pdf; pages: 16
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Thaler, Richard H & Shefrin, H M, 1981. "An Economic Theory of Self-Control," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 392-406, April.
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  13. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244, March.
  14. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
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  26. Christopher D. Carroll, 1992. "How does future income affect current consumption?," Working Paper Series / Economic Activity Section 126, Board of Governors of the Federal Reserve System (U.S.).
  27. R. Glenn Hubbard & Jonathan Skinner & Stephen P. Zeldes, 1993. "The Importance of Precautionary Motives in Explaining Individual and Aggregate Saving," NBER Working Papers 4516, National Bureau of Economic Research, Inc.
  28. Heckman, James J, 1974. "Life Cycle Consumption and Labor Supply: An Explanation of the Relationship Between Income and Consumption Over the Life Cycle," American Economic Review, American Economic Association, vol. 64(1), pages 188-94, March.
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  30. Akerlof, George A & Dickens, William T, 1982. "The Economic Consequences of Cognitive Dissonance," American Economic Review, American Economic Association, vol. 72(3), pages 307-19, June.
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  34. Tomiyama, Ken, 1985. "Two-stage optimal control problems and optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 9(3), pages 317-337, November.
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