The modern economic model of consumer behavior is based on substantive and technical insights reviewed by Deaton (1992) and Attanasio (1999) and briefly summarized in what follows. We include some mathematical notation for the benefit of readers who are familiar with optimization techniques in general but not in the particular context of this volume. The gist of this and the other chapters’ arguments, however, may also be appreciated without explicit formalization. According to the Permanent Income Hypothesis, the difference between income and consumption (hence savings, or borrowing) is determined by forward-looking considerations in the presence of randomness of future income that is, households optimally choose their level of consumption in each period, subject to an intertemporal budget constraint, in order to control its volatility. [download]
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