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)
“The energy, the brutality, the scale, the contrast, the tension, the rapid change—and the permanent congestion—are what the New Yorker misses when he leaves the city.”
—In New York City, U.S. public relief program (1935-1943)
“The secret of success lies never in the amount of money, but in the relation of income to outgo.”
—Ralph Waldo Emerson (1803–1882)
“It is a good morning exercise for a research scientist to discard a pet hypothesis every day before breakfast. It keeps him young.”
—Konrad Lorenz (1903–1989)