Consumption dynamics with law of small numbers

Yingjie Niu, Yaoyao Wu, Siqi Zhao and Zhentao Zou

Journal of Economic Behavior & Organization, 2024, vol. 224, issue C, 915-923

Abstract: We propose an intertemporal consumption-saving model by exploring the implications of the Law of Small Numbers (LSN), a belief heuristic stating that any sample realization of a population should be representative of the population. First, the existence of the LSN reduces the precautionary savings demand. More importantly, we show that the LSN belief structure provides an alternative explanation for two fundamental anomalies in consumption theory: (1) excess sensitivity by showing that past changes in income predict future changes in consumption; and (2) excess smoothness by lowering consumption volatility and generating the empirical magnitude.

Keywords: Law of small numbers; Consumption; Excess sensitivity; Excess smoothness (search for similar items in EconPapers)
JEL-codes: B49 D11 E21 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:224:y:2024:i:c:p:915-923

DOI: 10.1016/j.jebo.2024.06.021

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