Life-Cycle Theory Of Consumption

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Life-cycle hypothesis are developed by Ando & Modigliani (1963) to help economists to understand the dynamic behaviour of consumers and solve economic decision on retirement savings regarding the rationalization of an individual’s income. The hypothesis is designed to maximize the utility of one’s income over his lifetime.
Figure 2.1 Life-cycle model to predict saving behaviour

Source: Rayat, R., Scott, S., Mullen, E., & Chen, Y. (2015) Modigliani's Life Cycle Theory of Consumption. Retrieved August 5, 2016 from https://rpubs.com/RAAJ/110886
Figure 2.1 provides a graphical representation. The saving area during the work phase represents the employees’ positive savings in the expectation of the future retirement (Pistaferri, 2009). While,
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Furthermore, Mitchell, &Utkus (2003) also have adopted life-cycle hypothesis to evaluate the enthusiasms of households planning for retirement. They discovered that patterns of household saving behaviour can be explained by life-cycle theory. The statement is supported by Mitchell &Utkus (2003)’s study where savings generally increases with income and age, as well as positively correlated with education and accumulated wealth. They found that younger employees are more likely to be net-borrowers, as they borrow from the future by means of their use of debts to boost current consumption; whereas middle-age employees are tend to be net-savers and purchasers of financial assets and enter phase which they accumulated for their life upon retirement. Retirees’ labour income will be weaken or vanish which will then diminish their financial assets to finance old-age…show more content…
Lusardi & Mitchell (2014) stated that Life-cycle model that incorporates financial literacy indicates that more than half of the observed wealth inequality can be explained by financial literacy. Further, knowledge of stock market and differentiate between levels of financial knowledge is important in retirement saving decisions as they are related to the financial markets. They suggest that concepts that explained fundamental saving and investment decisions underlying the life cycle model are (1) skill and capability of calculating interest rates, (2) understanding of inflation, (3) understanding of risk diversification. Many researches have been done showed that life cycle optimization process can be explained by consumer preferences, the economic environment and social safety net benefits (Lusardi, & Mitchell,

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