Friedman's Permanent Income Hypothesis
After the Second World War, it was noticed that a model in which current consumption was just a function of current income clearly too simplistic. It could not explain the fact that the long-run average propensity to consume seemed to be roughly constant despite the marginal propensity to consume being much lower. Friedman's Permanent Income Hypothesis are one of the models which seeks to explain this apparent contradiction.
According to the Permanent Income Hypothesis, permanent consumption, CP, is proportional to permanent income, YP. Permanent income is a subjective notion of likely medium-run future income. Permanent consumption is a similar notion of consumption.
Actual consumption, C, and actual income, Y, consist of these permanent components plus unanticipated transitory components, CT and YT, respectively.
CPt =β2YPt
Ct = CPt + CTt
Yt = YPt + YTt
Read more about this topic: Intertemporal Choice
Famous quotes containing the words friedman, permanent, income and/or hypothesis:
“Corporate America will likely be motivated to support child care when it can be shown to have positive effects on that which management is concerned about—recruitment, retention and productivity. Indeed, employers relate to child care as a way to provide growth fostering environments for young managers.”
—Dana E. Friedman (20th century)
“Universal suffrage should rest upon universal education. To this end, liberal and permanent provision should be made for the support of free schools by the State governments, and, if need be, supplemented by legitimate aid from national authority.”
—Rutherford Birchard Hayes (1822–1893)
“Strictly speaking, every citizen above a certain level of income is guilty of some offense.”
—Max Frisch (1911–1991)
“It is an hypothesis that the sun will rise tomorrow: and this means that we do not know whether it will rise.”
—Ludwig Wittgenstein (1889–1951)