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Starting with the path-breaking work of Yale's Irving Fisher, economists, including six Nobel Laureates, have spent close to a century developing the life-cycle model. This model covers the gamut of personal economic decisions, including spending, saving, borrowing, insuring, matriculating, choosing careers, choosing jobs, choosing locations, marrying, having children, divorcing, retiring, contributing to retirement accounts, taking Social Security, making gifts and bequests, buying insurance, and making investment decisions about how much of your savings to invest in safe assets and how much to invest in risky assets.

Each of these financial, human capital, and demographic choices entails benefits and costs. The life-cycle model provides a framework for making decisions along one's life path. The framework is standard microeconomic theory of household behavior, extended to deal with decision making that occurs over time as well as across times -- good times and bad times.

The short-hand for this framework is life-cycle consumption smoothing, where "smoothing" references the need to spread your economic resources over your lifetime, taking into account that your future is highly uncertain. The presentation and intuitive application of consumption smoothing will be central to this course.

The life-cycle model's focus is highly practical, but discerning its recommendations can be complex, particularly when there are limits on borrowing and when one faces multiple, interconnected uncertainties, including uncertain future labor earnings, healthcare expenditures, rates of return, inflation rates, and government policies.

Traditional life-cycle economics assumes that households are consistent and rational in making life-path choices. But a new school of thought, known as behavioral finance, which is deeply influenced by the fields of psychology and neurology, has questioned that assumption. This course will survey behavioral finance and its findings as they pertain to life-cycle decision making, but do so after first spelling out the traditional approach.
Updated 3/4/2010