3.4 - permanent income hypothesis (aggregate demand)

milton friedman, 1957

consumers don’t make decisions based on just _____ ______

current income

households vary consumption patterns due to:

• permanent/normal income (stable incomes over 5-10 years leads to more consumption/savings)

consumption doesn’t change if consumers percieve income changes to be __________

transitory (variable/changing) e.g. a bonus

why is is the permanent income hypothesis plausible?

• it would be irrational to consume based on short-term income changes

• it would result in a high trade off (decreased future utility)

permanent income hypothesis limits: high vs low income

• HI: already have wealth, income changes aren’t spent

• LI: more likely to spend income increases, as they’re under more pressure

factors affecting life cycle hypothesis: unexpected increase windfall

• e.g. winning lottery, bonus

• more likely to instantly increase spending (party! 🥳)

factors affecting life cycle hypothesis: subjectivity

• some think any income change is permanent/transitory

• depends on the person!