Background
Intertemporal substitution is a foundational concept in economics that examines how consumers alter their consumption patterns over various periods based on relative prices, interest rates, or expected changes in income. It hinges on the idea that consumers derive utility not from consuming a good at a single point in time but from an optimalspread of consumption across different periods.
Historical Context
Intertemporal substitution has its roots in the broader theories of consumer choice and utility maximization. Early references to intertemporal choices can be linked to the work of economists like Irving Fisher in the early 20th century, but it gained more structured focus with the development of neoclassical models in the mid-20th century. Robert E. Lucas Jr. propelled this concept further through his work on rational expectations and its implications for the consumption theory.
Definitions and Concepts
Intertemporal substitution refers to the propensity of consumers to adjust their consumption timing based on expected changes in factors like interest rates or future prices. This adjustment can either lead to increased present consumption at the expense of future consumption or vice versa. The elasticity of intertemporal substitution (EIS) captures the responsiveness of essential human actions—saving and consumption—to changes in the rate of return or other economic variables over time. Here, the consumer’s preferences are usually described by a utility function, which quantifies their satisfaction levels.
Major Analytical Frameworks
Classical Economics
Classical economics laid the ground rules for intertemporal decision-making but focused more on investment than on consumption timing.
Neoclassical Economics
Neoclassical models provide one of the most comprehensive frameworks for understanding intertemporal substitution. The representative agent’s behavior is analyzed under a utility function to determine optimal consumption paths across various times, examining discounted utility to inform choices.
Keynesian Economic
Keynesian economics, primarily concerned with aggregate demand and short-term economic fluctuations, does recognize the notion, but it largely emphasizes present consumption levels and demand-driven constraints rather than timing.
Marxian Economics
Marx’s focus was not specifically on consumer intertemporal choices, but on broader capital accumulation dynamics over time. Hence, intertemporal substitution is peripherally addressed.
Institutional Economics
Institutional economics would interpret intertemporal choices with contextual importance, analyzing social, cultural, or institutional contexts affecting individual decision-making across time.
Behavioral Economics
Behavioral economics branches from neoclassical theories by investigating how real human behavior deviates due to heuristics, biases, and other psychological phenomena. It may account for systematic variations in intertemporal discounting that pure rational models might overlook.
Post-Keynesian Economics
Post-Keynesian scientists focus on uncertainty and non-neutrality of money over time, which might challenge strict notions of pure rational intertemporal substitution.
Austrian Economics
Austrians frame intertemporal choices concerning time preference, a primal theory anchoring on individual preference for present versus future gratifications. They analyze consumption in light of entrepreneurial foresight.
Development Economics
Development economists examine intertemporal substitutions in savings and investment decisions affecting long-term growth trajectories, indicating the impacts of policy measures at different stages.
Monetarism
Monetarists may critique or support related monetary policies by observing intertemporal choices consumers make in response to expected monetary expansions or contractions.
Comparative Analysis
Each framework brings unique perspectives and analytical tools when contextualizing intertemporal substitution. These views offer comprehensive understandings, from abstract rational models to empirical observations to insights about human behavioral deviations and long-term developmental theories.
Case Studies
Specific case studies can inspect intertemporal consumption in various economies during fiscal changes, regime changes, inflation periods, or other significant socioeconomic transformations.
Suggested Books for Further Studies
- “The Theory of Interest” by Irving Fisher
- “A Monetary History of the United States” by Milton Friedman and Anna Schwartz
- “Rational Expectations and Econometric Practice” by Robert E. Lucas Jr. and Thomas J. Sargent
- “Behavioral Economics: Toward a New Economics by Integration with Traditional Economics” by Fumio Hayashi
Related Terms with Definitions
- Utility Function: Represents consumer preferences, showing satisfaction from varying bundles of goods and services over time.
- Elasticity of Intertemporal Substitution (EIS): Measures the responsiveness of changes in consumption from one period to another as relative conditions vary.
- Time Preference: Individual preference for consumption occurring in the present versus consumption deferred to the future.
This dictionary entry succinctly encapsulates the essence of “Intertemporal Substitution,” from foundational elements to complex economic models.
