Abstract
This paper simply expands two famous consume functions referring to macro-economics: Keynesian consumption function and Life-cycle consumption function; attempting to introduce the empirical proxy variance of irrational facts: money illusion and over-reaction, we rebuild a new Keynesian consumption model and Life-cycle consumption model, both of which are based on the hypothesis of resident’s irrational behavior. Then we use the new model to empirically test the macroeconomic years’ data of China’s urban residents from 1978 to 2013 and China’s rural residents from 1985 to 2013. The empirical results show that all residents of China are irrational, however, the reasons of cause irrational consumption are different, and the urban residents may be for money illusion, but the rural residents may show over-reaction to price volatility. Finally, we give theory analysis about the differences of the two irrational consumption behaviors and the results of the paper.
Highlights
The theoretical research on consumption functions is a significant project
The empirical results show that all residents of China are irrational, the reasons of cause irrational consumption are different, and the urban residents may be for money illusion, but the rural residents may show over-reaction to price volatility
After establishing Keynesian irrational consumption function and life cycle consumption function, the macro economic data of Chinese residents are applied to the two models using OLS and Generalized Method of Moments (GMM) fitting to test whether the consumption behavior of Chinese consumers are influence by irrational factors, such as money illusion and overreaction as expected
Summary
The theoretical research on consumption functions is a significant project. It is of greatly challenging and innovative. Both of prominent Economists (Keynes and Friedman) in 20th century are well known for their researches on consumption functions. It can be deemed without fear of exaggeration that consumption function theory is one of the most important foundations of macroeconomics.
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