science

Intertemporal consumption

Intertemporal consumption is a science topic covered in the lgStudy science library. This page brings together a partial reference excerpt, illustrations, worked examples, real-world applications and a short study plan, so you can understand Intertemporal consumption rather than just read about it. In short: Economic theories of intertemporal consumption seek to explain people's preferences in relation to consumption and saving over the course of their lives. The earliest work on the subject was by Irving Fisher and Roy Harrod, who described 'hump saving', hypothesizing that savings would be highest in the middle years of a person's life as they saved for retirement.

Key takeaways

Intertemporal consumption belongs to science; place it in that map before memorising details.
Learn the definition first, then one example that makes the definition concrete.
Connect Intertemporal consumption to a quantity you can measure, compute or draw — that is where exam questions come from.
Reproduce the core statement of Intertemporal consumption from memory before moving on to harder problems.

Reference excerpt

Economic theories of intertemporal consumption seek to explain people's preferences in relation to consumption and saving over the course of their lives. The earliest work on the subject was by Irving Fisher and Roy Harrod, who described 'hump saving', hypothesizing that savings would be highest in the middle years of a person's life as they saved for retirement. In the 1950s, more well-defined models were built on discounted utility theory and approached the question of inter-temporal consumption as a lifetime income optimization problem. Solving this problem mathematically, assuming that individuals are rational and have access to complete markets, Modigliani & Brumberg (1954), Albert Ando, and Milton Friedman (1957) developed what became known as the life-cycle model. See Intertemporal choice § Modigliani's life cycle income hypothesis for details. The life-cycle model of consumption suggests that consumption is based on average lifetime income instead of income at any given age. First, young people borrow to consume more than their income, next, as their income rises through the years, their consumption rises slowly and they begin to save more. Lastly, during their retirement these individuals live off of their savings. Furthermore this theory implies that consumption is smoothed out relative to a person's income which is the reason economists set consumption proportional to potential income rather than actual income. Attempts to test the life-cycle model against real world data have met with mixed success. In a review of the literature, Courant, Gramlich and Laitner (1984) note "but for all its elegance and rationality, the life-cycle model has not tested out very well". The main discrepancies between predicted and actual behaviour is that people drastically 'underconsume' early and late in their lifetime by failing to borrow against future earnings and not saving enough to adequately finance retirement incomes respectively. People also seem to 'overconsume' during their highest earning years, the elderly do not consume from their assets as would be expected (particularly from their household equity) and also treat windfall gains in a manner inconsistent with the life-cycle model. Specific alterations to the theory have been proposed to help it accommodate the data; a bequest motive, capital market imperfections such as liquidity constraints, a changing individual utility function over time or a particular form of expectation as to future income. Behavioural economists have proposed an alternate description of intertemporal consumption, the behavioural life cycle hypothesis. They propose that people mentally divide their assets into non-fungible mental accounts – current income, current assets (savings) and future income. The marginal propensity to consume (MPC) out of each of these accounts is different. Drawing upon empirical studies of consumption, superannuation and windfall gains they hypothesize that the MPC is close to one out of current income, close to zero for future income and somewhere in between with respect to current assets. These differing MPCs explain why people 'overconsume' during their highest earning years, why increasing superannuation contributions does not cause current savings to be reduced (as the life-cycle model implies) and why small windfall gains (which are coded as current income) are consumed at a high rate but a higher proportion of larger gains is saved.

See also Albert Ando Dissaving Intertemporal choice Permanent income hypothesis Temporal discounting Wealth elasticity of demand

References Fisher, I (1930): The Theory of Interest Harrod, R. (1948): Towards a Dynamic Economics Friedman, M. (1957): A Theory of the Consumption Function Modigliani, F. & Brumberg, R. (1954): 'Utility analysis and the consumption function: An interpretation of cross-section data'. In: Kurihara, K.K (ed.): Post-Keynesian Economics Shefrin, H. & Thaler, R. (1992): 'Mental Accounting, Saving and Self-Control'. In: Lowenstein, G. & Elster, J. (eds.) Choice over Time

Worked examples

Example 1 — a first encounter with Intertemporal consumption

Start with the simplest possible case. Write down what Intertemporal consumption claims or describes in one sentence, then invent the smallest concrete situation in which that sentence is true. In science, the smallest case is usually a single object, a single equation or a single measurement. Check that every symbol or term in your sentence has a meaning in that case.

Example 2 — changing one variable

Take the situation from Example 1 and change exactly one quantity: double it, halve it, or set it to zero. Predict what should happen to Intertemporal consumption before you calculate. Comparing your prediction with the result is the fastest way to find out whether you understand the idea or only the words.

Example 3 — an exam-style question

Typical questions about Intertemporal consumption ask you to (a) state it precisely, (b) apply it to given data, and (c) explain a limitation. Practise writing all three answers in under five minutes; the third part is what separates a full-mark answer from an average one.

Applications of Intertemporal consumption

In research: Intertemporal consumption appears in science research whenever the underlying quantities have to be modelled precisely. Papers usually cite it as a starting assumption and then explore where it breaks down.
In technology and industry: Engineering practice reuses Intertemporal consumption in design rules, simulations and safety margins. Knowing the idea lets you read a specification sheet and understand why the numbers look the way they do.
In the classroom: Intertemporal consumption is common in secondary-school and first-year university syllabi. It links to neighbouring topics Consumption, Intertemporal economics, so understanding it makes those chapters shorter.
In everyday life: Look for Intertemporal consumption outside the textbook — in sport, cooking, traffic, electronics or the sky above you. An example you found yourself is remembered far longer than one you were given.

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How to study Intertemporal consumption in 20 minutes

Read the reference excerpt below once, without taking notes.
Close the page and write down what Intertemporal consumption means in your own words.
Compare your version with the excerpt and mark what you missed.
Work through the three examples above with pen and paper.
Explain Intertemporal consumption out loud to somebody else — or to Teacher Smith in the lgStudy chat.

Frequently asked questions

What is Intertemporal consumption in simple terms?

Why does Intertemporal consumption matter?

Because it connects several science ideas at once: it gives you a definition you can apply, a quantity you can calculate, and a way to check whether a result is plausible.

How should I study Intertemporal consumption?

Read the excerpt, restate it from memory, then work through the examples and applications listed on this page. The five-step study plan above takes about twenty minutes.

What does this page cover?

It gives you a compact reference excerpt plus original lgStudy explanations, examples, applications and study material on Intertemporal consumption.