income decomposition and the role of luck

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Last updated 12:14 PM on 5/11/26
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6 Terms

1
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consumption response diagram

anticipated income change → anticipated increase or anticipated decline

unanticipated income change → transitory shock (positive or negative) or permanent shock

2
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consumption response assumptions

  • consumption does not respond much to anticipated change as they have already considered and adapted to the change

  • consumption changes one to one with permanent income

  • consumptions does not change much with transitory shocks

  • things will change from household due to borrowing constraints

3
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natural log of income or wage

yit = natural log of income or wage

ft(Xit) = anticipated change

uit = unanticipated

<p>y<sub>it</sub> = natural log of income or wage </p><p>f<sub>t</sub>(X<sub>it</sub>) = anticipated change</p><p>u<sub>it</sub> = unanticipated </p>
4
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what affects the anticipated part

  • age/experience

  • education/human capital

  • regional effects

  • discrimination

  • urban/rural

  • prices

5
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Friedmans permanent income hypothesis

basic intuition that individuals would wish to smooth consumption and do not want it to fluctuate with SR income fluctuations, APC = MPC

6
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examples of unanticipated transitory part

  • unemployment

  • minor injury

  • loss or gain bonus

  • winning lottery