What Is the Life Cycle Theory of Savings?
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0:00 - 0:02♪ [music] ♪
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0:13 - 0:16- [Narrator] What is
the lifecycle theory of savings? -
0:16 - 0:20It's the theory about how a person
chooses to spend and save -
0:20 - 0:21throughout her lifetime.
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0:21 - 0:23But before diving
into these choices, -
0:23 - 0:26we need to examine
a person's typical income over time. -
0:27 - 0:30Most people's incomes
don't stay flat their entire lives, -
0:30 - 0:32they change in predictable ways.
-
0:32 - 0:35Here's a typical pattern
showing a person's income -
0:35 - 0:36over their life,
-
0:36 - 0:38with their income
on the vertical axis -
0:38 - 0:41and time on the horizontal axis.
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0:41 - 0:43When you're young
and still in school, -
0:43 - 0:45you might make
a little bit of money -
0:45 - 0:48waiting tables
or occasionally mowing lawns. -
0:48 - 0:51Your first job out of school --
it's going to pay a lot more. -
0:51 - 0:53After a few years of experience
-
0:53 - 0:55and hopefully
a few raises along the way, -
0:55 - 0:57you make more than you ever have.
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0:57 - 1:00Then, as you age,
you look forward to retirement -
1:00 - 1:02when your income falls.
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1:02 - 1:03But you're no longer working
-
1:03 - 1:06and you could really enjoy
your golden years. -
1:06 - 1:08Now let's imagine
if your consumption followed -
1:08 - 1:12the same path as your income
and you never saved or borrowed. -
1:12 - 1:14You'd struggle when young,
-
1:14 - 1:17and you'd be unable
to invest in an education. -
1:17 - 1:19Then, you'd spend
every cent you make -
1:19 - 1:21during your prime working years.
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1:21 - 1:24Well, that sounds like a lot of fun,
but without any savings, -
1:24 - 1:27your income will drop
suddenly when you retire, -
1:27 - 1:29and so will your consumption.
-
1:29 - 1:32Your golden years
wouldn't be so golden. -
1:32 - 1:36So instead, people tend to follow
a lifecycle theory of savings. -
1:36 - 1:38A person can start out consuming
more than she makes, -
1:38 - 1:40borrowing to fill that gap,
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1:40 - 1:43and to pay for things
like an education. -
1:43 - 1:45Then during
her prime working years, -
1:45 - 1:47she makes more than she consumes,
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1:47 - 1:49paying down her debt
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1:49 - 1:52and saving the extra income
for retirement. -
1:52 - 1:55And when retirement comes,
she can spend those savings -
1:55 - 1:58and enjoy the golden years
even without working. -
1:58 - 2:00We call it "dissaving,"
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2:00 - 2:02but that just means
spending your own savings. -
2:03 - 2:07Now, of course, many people deviate
from this exact path, -
2:07 - 2:08depending on details.
-
2:08 - 2:10Most people, for example,
-
2:10 - 2:13they consume less in college
than they do as professionals. -
2:13 - 2:16Ramen noodles are no longer
a staple of my diet, -
2:16 - 2:19but generally speaking,
many people follow a pattern -
2:19 - 2:23of borrowing, saving and dissaving
-
2:23 - 2:26to smooth their consumption path
over their lifetime. -
2:26 - 2:28If you'd like to learn more
-
2:28 - 2:30about the importance
of saving early and often, -
2:30 - 2:32click here.
-
2:32 - 2:33Or, if you'd like
to test your knowledge -
2:33 - 2:36on lifecycle theory
of savings, click here. -
2:36 - 2:38♪ [music] ♪
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-
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- Title:
- What Is the Life Cycle Theory of Savings?
- Description:
-
According to the Life Cycle Theory of Savings, our spending and savings habits tend to change over time, and our income has a lot to do with it. Learn more with this video!
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- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Dictionary of Economics
- Duration:
- 02:47
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