A household enjoys a high, stable income. At time T1, the household receives credible news that its income will permanently fall to a lower level at a future time T2. Which of the following consumption patterns best represents the behavior of a household that is unable to borrow against future income?

Consumption Response to Future Income Shocks

A household experiences a specific income path: a high, stable income until time T2, but at an earlier time T1, they receive credible news that their income will permanently fall at T2. Match each of the following household types to the consumption path they are most likely to follow in response to this news.

Analysis of Consumption Response to Future Income News

Consider a household that initially has a high, stable income. At a specific point in time (T1), the household receives credible information that its income will permanently decrease at a future date (T2). According to a standard economic model of a forward-looking, consumption-smoothing household, its consumption will drop immediately at T1 and then remain constant at this new, lower level.

Comparing Household Consumption Responses to Negative Income News

A forward-looking household aims to maintain a relatively stable level of spending over its lifetime. This household initially has a high, stable income. It then receives credible news that its income will permanently fall in one year. After that year passes, the income drops to the new, lower level. Arrange the following time periods in order from the period with the highest amount of household saving to the period with the lowest amount of household saving.

In a model where a household receives credible news of a future permanent income decrease, a forward-looking household that is not credit-constrained will immediately reduce its spending to a new, sustainable level. This behavior, aimed at maintaining a relatively stable standard of living despite income fluctuations, is known as ____.

A household enjoys a high, stable income. At time T1, the household receives credible news that its income will permanently fall to a lower level at a future time T2. The household understands the importance of saving for the future but has a strong preference for immediate satisfaction and tends to procrastinate on making difficult financial adjustments. Which of the following best describes this household's likely consumption path?

Comparing Household Responses to Future Income Shocks

Present Bias

Comparing Consumption Smoothing and Present Bias in Response to Future Income Decrease