Consumption and Savings Decisions: Teaching The Precautionary Motive In Intermediary Macroeconomics Courses

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Most undergraduate macroeconomics courses do not address the precautionary motive, an essential factor behind savings decisions. This motive arises when future income is uncertain; consequently, we must use models in which consumers live for several periods, and their future income is treated as a random variable. To simplify the exposition, we consider a model with two periods in which future income is merely positive (employed) or null (unemployed). In this framework, we illustrate how the precautionary motive leads consumers to save more due to unemployment risk. After exposure to this material, we hope that students who have not yet studied the precautionary motive can understand it and incorporate it into their analysis of consumer behavior. In addition, teachers can use this as a guide to approach this important topic.

Fernando Barros, Fábio A. R. Gomes, and Thalita S. Calcini