Permanent income hypothesis

In the macroeconomic view of expectations and consumer demand for a longer period taken for example in the IS- LM model temporary assumptions can not be used. Rather, there are different income hypotheses that attempt to make valid predictions by means of different approaches. The permanent income hypothesis was buoyed by Milton Friedman. According to the permanent income hypothesis does not meet The household consumption decision based on their short-term disposable income, but on the basis of their permanent income. Permanent income is the average income per period, is expecting a budget, taking into account a longer time horizon.

The conclusion of the permanent income hypothesis is that temporary, short-term changes in income of the consumers, have little effect on their consumption spending, while permanent income changes may have a greater impact on consumer behavior.

Dogmatic approach

Economic agents expect over the lifecycle disposable income flows that determine the total assets. In this case, due to inheritance motives ( dynastic preferences ) an infinite time horizon is used. Analytical results:

The income stream is in this case composed of the present value of labor income, financial income and corporate income.

Upon formation of the harmonic mean of the revenue streams may be represented as a current of the permanent income:

Permanent income can thus be understood as a perpetual annuity of the assets of economic subject:

The corresponding consumption function is then:

Like the life-cycle hypothesis is the hypothesis of permanent income, a further development of the Keynesian consumption function.

Bibliography

Peren, Francis W.: income, consumption and saving of households in the Federal Republic of Germany since 1970: analysis using makrooekonomischer consumption functions. Peter Lang, Frankfurt / Bern / New York 1986 3- 8204-9006 -X.