LIFE CYCLE INCOME AND CONSUMPTION IN COLOMBIA
ROBERTS, DAVID LESLIE
Doctor of Philosophy
This thesis applies the 1978 Colombian EH-4 cross-sectional household budget study to two empirical versions of the Modigliani-Ando-Brumberg life cycle consumption model. The first version uses "normal income" as a proxy for life cycle income. Normal income is defined as a weighted average of the mean income of the socioeconomic groups (education, occupation, home-tenure, region) to which an individual belongs. As both the simple linear case and a slightly more complex approach permitting interactions among grouping variables, the marginal propensity to consume from normal income is less than one but greater than the MPC from the proxy for transitory income. The second empirical version derives from a one-parameter intertemporal utility function. In this model consumption depends on expected income in each period and the market interest rate. An individual's expected income i years in the future is defined as the mean income of members of his education/occupation group who are currently i years older. For a given interest rate (r), permanent income is (DIAGRAM, TABLE OR GRAPHIC OMITTED...PLEASE SEE DAI) where Y(,i) is expected income each year and L is the end of the planning horizon. Y('*) is calculated for various interest rates. The "best" interest rate is chosen as the rate which provides the highest adjusted correlation between Y('*) and consumption. For most groups the interest rate chosen is 7.5 percent. For all groups, estimated MPC from Y('*) is close to one and greater than the MPC from transitory income. Hypothesis tests performed on several predictions of the M-A-B do not reject the predictions. If low income individuals are less willing to plan for the future (that is, they have high psychological discount rates or short time horizons) than high income individuals, they should have higher marginal consumption propensities from both permanent and transitory income throughout the life cycle. On the other hand, if all individuals tend to have the same psychological rates but low income persons are less able to borrow against future income due to market imperfections, the predicted MPC's from permanent income depend on relative variation in income across the life cycle and vary by age. For transitory income, young low income individuals will apply any variation in income to current consumption since they are consuming at less than their permanent income level, but the MPC from transitory income should decline with age. Hypothesis tests tend to reject the higher psychological discount rate assumption and favor the market imperfections assumption.