This chapter deals with three issues related to consumption decisions under uncertainty, namely, (i) the determinants of risk aversion for future consumption; (ii) the impact of uncertainty about future resources on current consumption and (iii) the separability of consumption decisions and portfolio choices. These issues are discussed in the context of a simple model introduced, together with our assumptions, in Section 1. The first issue is motivated and treated in Section 2, the conclusions of which are summarised in proposition 2.5. The other two issues are treated in Section 3 under the assumption that there exist perfect markets for risks, and in Section 4 under the converse assumption.

Some technical results needed in the text are collected in Appendices A, B and C; a simple graphical illustration of our major result, theorem 3.3, is given in Appendix D.

The model and the assumptions

Model

Following Fisher (1930), we study the problem faced by a consumer who must allocate his total wealth y between a flow of current (or ‘initial’) consumption c1 and a residual stock (y – c1) out of which future consumption c2 (including bequests) will be financed. We restrict our attention to the aggregate values of present and future consumption, or equivalently to a single-commodity, two-period world.

We conceive of the consumer's wealth y as being the sum of two terms:

1. The (net) market value of his assets, plus his labour income during the initial period, to be denoted altogether by y1.

2. The present value of his future labour income, plus additional receipts from sources other than his current assets.