Macroeconomics

F I G U R E  

1 7 - 8

Second-period 

consumption, C

2

Y

1

Budget

constraint

Borrowing

constraint

First-period 

consumption, C

1

A Borrowing Constraint

If the consumer 

cannot borrow, he faces the additional con-

straint that first-period consumption cannot

exceed first-period income. The shaded area

represents the combinations of first-period 

and second-period consumption the consumer

can choose.

---

binding, and consumption in both periods depends on the present value of life-

time income, Y

1

+ [Y

2

/(1 

+ r)]. For other consumers, the borrowing constraint

binds, and the consumption function is C

1

= Y

1

and C

2

= Y

2

. Hence, for those con-

sumers who would like to borrow but cannot, consumption depends only on current income.

17-3

Franco Modigliani and the 

Life-Cycle Hypothesis

In a series of papers written in the 1950s, Franco Modigliani and his collabora-

tors Albert Ando and Richard Brumberg used Fisher’s model of consumer

behavior to study the consumption function. One of their goals was to solve the

consumption puzzle—that is, to explain the apparently conflicting pieces of evi-

dence that came to light when Keynes’s consumption function was 

confronted with the data. According to Fisher’s model, consumption depends on

a person’s lifetime income. Modigliani emphasized that income varies 

systematically over people’s lives and that saving allows consumers to move

C H A P T E R   1 7

Consumption

| 509