3.1 The Tradeoff between Present and Future Consumption

The analysis of consumer and producer theory thus far has assumed a single time period within which a decision was being made. The scene opens; you have €20 in your pocket to spend on apples and bananas; you choose how to divide your money; you eat the fruit, and the scene ends. This is called a “static” or “one-period” model.

The economy itself, obviously, exists within time; money itself, as you learn in Econ 1, serves a purpose both within a single period (as a “medium of exchange”) and across time (as “store of value”). And many economic decisions come down to allocating resources between current and future uses. If you have that €20, should you spend it all on apples and bananas, or should you save some of it for future uses? Should you buy those apples and bananas with a credit card, and pay at some point in the future, possibly with interest?

As with any tradeoff, any decision comes with an opportunity cost; and the “good 1 - good 2” model we have can easily be adapted to model the tradeoff between present and future consumption. For the purposes of this chapter, we’ll just think of a two-period model, where “good 1” is “consumption now” and “good 2” is “consumption in the future.” However, just as “good 1 - good 2” model could be extended to any number of goods, so too can we think of this as a simplification of a more general model in which we consider decisions made over a larger number of time periods.