Consumption Planning with Credit Constraints
Consider the following scenario and explain how the individual's spending behavior would likely deviate from the standard prediction that people adjust consumption in anticipation of predictable future income changes. Pinpoint the specific factor causing this deviation.
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A recent law school graduate, currently working as a junior associate, has just accepted a partnership offer at their firm. The new, much higher salary will begin in one year. Assuming this individual makes financial decisions consistent with the theory that people plan their spending over their entire lives and has the ability to borrow, what is the most probable immediate effect on their current spending?
Explaining Consumption Behavior
According to a life-cycle view of personal finance where individuals plan their spending over their lifetime, a person who is certain to receive a large, permanent salary increase next year will typically wait until the higher salary is actually paid before increasing their level of spending.
Consumption Decisions and Credit Access
The Role of Credit in Consumption Smoothing
Assumptions of Anticipatory Consumption
Consumption Planning with Credit Constraints
Consider two individuals, Alex and Ben, who are both 30 years old and have identical jobs and current incomes. Both are guaranteed a large, permanent promotion with a significant salary increase exactly one year from today. Alex has a high credit score and can easily borrow money at a low interest rate. Ben has a poor credit history and finds it impossible to get a loan. Based on the theory that people plan their spending over their lifetime, how would you expect their current consumption levels to compare?
An individual is certain they will receive a large, permanent salary increase one year from now. They are considering increasing their spending immediately by taking out a loan. Just as they are about to make this decision, the interest rate on all available loans increases substantially. How would this change in the cost of borrowing likely affect their immediate consumption decision, based on a life-cycle planning perspective?
A senior employee is five years away from a mandatory retirement date, at which point their income will predictably and significantly decrease. According to the theory that individuals plan their spending over their entire lives to maintain a stable standard of living, what is the most likely immediate adjustment this employee will make to their current spending and saving habits?