Permanent income hypothesis
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The permanent income hypothesis (PIH) is a theory of consumption that was developed by the American economist Milton Friedman. In its simplest form, the hypothesis states that the choices made by consumers regarding their consumption patterns are determined not by current income but by their longer-term income expectations. The key conclusion of this theory is that transitory, short-term changes in income have little effect on consumer spending behavior.
Measured income and measured consumption contain a permanent (anticipated and planned) element and a transitory (windfall gain/unexpected) element. Friedman concluded that the individual will consume a constant proportion of his/her permanent income; and that low income earners have a higher propensity to consume; and high income earners have a higher transitory element to their income and a lower than average propensity to consume.
In Friedman's permanent income hypothesis model, the key determinant of consumption is an individual's real wealth, not his current real disposable income. Permanent income is determined by a consumer's assets; both physical (shares, bonds, property) and human (education and experience). These influence the consumer's ability to earn income. The consumer can then make an estimation of anticipated lifetime income.
[edit] References
- Friedman, Milton (1957). A Theory of the Consumption Function. Princeton Univ Press. ISBN 13 978-0691041827.
- Romer, David (2006). Advanced Macroeconomics. McGraw-Hill Irwin. ISBN 13 978-0-07-297730.
[edit] See also
- Consumption function
- Life cycle hypothesis
- Income#Meaning in economics and use in economic theory
- Milton Friedman
- Ricardian equivalence
[edit] External links
- Robert Schenk, "Permanent-Income Hypothesis"
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