The Life Cycle Model (LCM) is based on the idea that people save over the course of their lives so as to smooth their consumption; this is necessary because people earn very different amounts during different phases of life. Given that most income is earned in middle life, it can be sensible to borrow at the beginning of life (to invest in education, for instance) and then repay that debt and save for old age during the main working years.

One way this model can be formulated is by defining one period of time as when a person is ‘young’ and another as when they are ‘old.’ The relative preference for wealth at each of these times is a function of the interest rate, provided no other uncertainties are included in the model. If we assume people have perfect knowledge about the future, they will probably borrow early on, save during midlife, and consume their savings down to zero in old age. Note that this assumes the benefits from education are sufficient to justify borrowing as well as that people will not want to bequeath any money to children or others when they die.

Given that in reality people don’t know how long they will live, a model that does not consider uncertainty has much less explanatory power than one that incorporates it. People who don’t know the future will be more likely to hedge their position in one way or the other, depending on their decision-making style. They will save more, so that they will have some money on which to survive even if they live longer than they expect, but they may also have a higher marginal rate of time preference, since they know they could die unexpectedly. Idealized rational people of the sort beloved by economists would certainly save more if they didn’t know how long they would live. Actual people might be tempted to focus on their present needs, rather than giving as much weight to a far off and uncertain future as may be wise.

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