Consumption Smoothing

Published on: Wed Dec 03 2008

I was reading an interesting paper yesterday, which I happened upon while reading a news story. The paper is called "Shocks, stocks and socks: consumption smoothing and the replacement of durables during an unemployment spell." by Martin Browning and Thomas F. Crossley. It's quite an interesting paper. To summarize, when the times are bad people hold off on buying replacements of durable items. That struck a cord with me, because I used to do that all the time! For example, my cats kept shredding my towels, and instead of buying new towels I just made do with scratched up towels. I liked the paper so much I think I would like to make a working model using either Maple or Excel. To get started I need to figure out what variables I have to assign. yt y = earnings t = time period r = interest rate S = minimum net assets of the Agent ct c = level of consumption of a nondurable q = quality {Low(1) or High(2)} dt = 0 = Keep existing durable dt = 1 = New low quality durable dt = 2 = New High quality durable p = price for new durable good pl = price of new low quality durable ph = price of new high quality durable (pl < ph) A = Cash on hand And the credit constrainst is represented by:
c + I(d=1) pl + I(d=2) ph < A - S
My first question? What does I(d=1) mean? It means the agent buys the low quality good. So what is this good for? I suppose I could show a graph where as the cash on hand changes the Agent becomes willing to either not buy a durable good, buy a low quality durable good or buy a high quality good.