absolute income hahypothesis

A theory developed by John Maynard Keynes which puts forward the idea that consumption will rise as
income rises, but not necessarily at the same rate.Keynes's consumption income relationship is known
as the absolute. income hypothesis which states that when income increases consump- tion also
increases but by less than the increase in income, and viceversa.According to Keynes psychological law
“men are disposed, as a rule and on the average, to increase their consumption as their income
increases, but not by as much as the increase in their income.According to the absolute income
hypothesis, when income rises, consumption also rises, but the increase in income is greater than the
increase in consumption, i.e., consumption increases but at a lesser rate. This indicates a non-
proportional relationship between consumption and income.Suppose, income is $100 and consumption
is $75 initially, which rise to $150 and $100 respectively. Then, As long as APC falls with an increase in
income, MPC will always be less than APC. Since the absolute income hypothesis postulates that APC
decreases with an increase in income, MPC will be less than APC.

The absolute income hypothesis can be stated by the following four postulates: (1) real income is a
stable function of real disposable income; (2) the marginal propensity to consume is a positive fraction
close to but less than unity; (3) the marginal propensity to consume is less than the average propensity
to consume ..

criticism of the Absolute Income Hypothesis

It fails to explain the long-run behaviour of consumption observed by Kuznets, where MPC=APC. The
theory did not explicitly account for the role of cyclical fluctuations or business cycles, where MPC<APC
over a short period only.

What is an example of Absolute income?

"Absolute income" is an economic term that simply describes the amount of money that an individual is
compensated for his or her work. Call it wages, salary, earnings, or take-home pay -- it's all income

Secular stagnation :-Secular stagnation is a theory that suggests that an economy can experience
persistent low GDP growth, low interest rates, and high long-term unemployment due to a deficiency in
aggregate demand. The term "secular" refers to long-term trends, as opposed to short-term
fluctuations.

Simon Kuznets :-
Hello, I wanted to discuss Irving Fisher and the concept of intertemporal change. Fisher was an American
economist who made significant contributions to the field of economics in the early 20th century. He is
best known for his work on the theory of interest rates and the quantity theory of money.

One of Fisher's key ideas was the concept of intertemporal change, which refers to the impact of
changes in the present on future outcomes. According to Fisher, individuals and businesses make
decisions based on their expectations of future events, such as changes in prices or interest rates. These
expectations can influence their behavior in the present, leading to intertemporal changes.

Fisher believed that intertemporal change played a crucial role in understanding economic fluctuations
and the business cycle. He argued that changes in expectations and future prospects can have a
significant impact on investment decisions and overall economic activity. For example, if businesses
anticipate a decline in future demand, they may reduce their investment and hiring, leading to a
slowdown in economic growth.

Fisher's ideas on intertemporal change have had a lasting impact on economic theory and policy. His
work laid the foundation for modern theories of investment, saving, and consumption. It also
highlighted the importance of considering the interplay between present and future economic
conditions when analyzing economic behavior.

In conclusion, Irving Fisher's contributions to the concept of intertemporal change have greatly
influenced our understanding of economic decision-making. His work continues to be relevant in
modern economic analysis and provides valuable insights into the dynamics of the
economy.Intertemporal change refers to changes that occur over time, and it can be observed in various
contexts such as economics, environmental science, and personal finance. Here's an example in the
context of economics:

**Example: Inflation and Purchasing Power**

Let's consider a scenario where there is a consistent inflation rate over several years. Inflation refers to
the general increase in prices of goods and services over time. As a result, the purchasing power of a
currency tends to decrease.
Imagine a person who has $1,000 in a savings account. If the inflation rate is 2% per year, the real value
of that money decreases over time. After one year, the purchasing power of $1,000 is effectively
reduced to $980 (considering 2% inflation). If this trend continues, the intertemporal change becomes
more apparent over several years:

- After 5 years: $1,000 has the purchasing power equivalent to $907.03.

- After 10 years: $1,000 has the purchasing power equivalent to $818.73.

This example illustrates how the value of money changes over time due to inflation, affecting the
purchasing power of individuals and businesses. It emphasizes the intertemporal nature of economic
variables and how they can have a significant impact on decision-making and planning over extended
periods.

Irving Fisher's income hypothesis is a theory that suggests individuals' consumption decisions are
primarily based on their current income. While this hypothesis provides valuable insights into consumer
behavior, it does have some limitations. Here are a few key limitations of Irving Fisher's income
hypothesis:

1. Ignoring wealth and other factors: Fisher's income hypothesis focuses solely on current income as the
determinant of consumption. However, it overlooks the role of other factors such as wealth, future
income expectations, and borrowing constraints, which can significantly influence consumption
decisions.

2. Time inconsistency: The income hypothesis assumes that individuals have consistent preferences over
time. However, research has shown that people's preferences and behaviors can change over time,
making it challenging to accurately predict consumption patterns based solely on current income.

3. Income volatility: Fisher's income hypothesis assumes a stable and predictable income stream for
individuals. In reality, income can be volatile, especially for those with irregular or unpredictable
earnings. This volatility can lead to fluctuations in consumption that are not adequately captured by the
income hypothesis.

4. Savings and investment: The income hypothesis focuses on consumption decisions and does not
explicitly consider saving and investment choices. Yet, individuals often allocate a portion of their
income to savings or investments, which can affect their consumption behavior independently of their
income level.

5. Psychological and social factors: Fisher's income hypothesis overlooks the influence of psychological
and social factors on consumption decisions. People's attitudes, beliefs, and social norms can
significantly impact their spending patterns, irrespective of their income level.

It is important to consider these limitations when applying Irving Fisher's income hypothesis in real-
world scenarios. While it provides a useful framework for understanding consumption behavior, it is
necessary to incorporate other factors and theories to obtain a more comprehensive understanding of
individuals' spending choices.

Md Endris:

Life cycle income hypothesis

ChatGPT (GPT-4):

The Life Cycle Income Hypothesis, proposed by Franco Modigliani, is an economic theory that suggests
individuals' consumption decisions are based on their expected lifetime income rather than just their
current income. This hypothesis takes into account the fact that individuals have different income
patterns throughout their lives and adjust their consumption accordingly.

According to the Life Cycle Income Hypothesis, individuals aim to maintain a stable standard of living
over their lifetime. Therefore, they make consumption decisions based on their expected average
lifetime income, rather than their current income alone. This hypothesis suggests that individuals may
save during periods of high income, such as during their peak earning years, to support their
consumption during periods of low income, such as retirement.

Key features and implications of the Life Cycle Income Hypothesis include:

1. Borrowing and saving: Individuals may borrow during periods of low income, such as when they are
young and starting their careers. They then repay these loans during periods of higher 1income. Saving
is also an essential component, as individuals accumulate wealth during high-income periods to support
consumption during low-income periods.
2. Consumption smoothing: The Life Cycle Income Hypothesis suggests that individuals aim to smooth
out their consumption over their lifetime. They do this by adjusting their saving and borrowing behavior
to maintain a consistent standard of living, despite fluctuations in income.

3. Retirement planning: The hypothesis emphasizes the need for individuals to save and accumulate
wealth during their working years to support their consumption during retirement when their income is
likely to decrease.

4. Income uncertainty: The Life Cycle Income Hypothesis recognizes that individuals face income
uncertainty throughout their lives. This uncertainty can influence their saving and consumption
decisions as they aim to mitigate the risks associated with income fluctuations.

Overall, the Life Cycle Income Hypothesis provides a framework for understanding how individuals make
consumption decisions over their lifetime, considering the variations in income they experience. By
considering expected lifetime income rather than just current income, this hypothesis offers a more
comprehensive view of consumer behavior and saving patterns.

While the Life Cycle Income Hypothesis provides valuable insights into individuals' consumption and
saving behavior, it also has some limitations. Here are a few key limitations of the Life Cycle Income
Hypothesis:

1. Perfect foresight assumption: The Life Cycle Income Hypothesis assumes that individuals can
accurately predict their future income throughout their lifetime. However, in reality, income uncertainty
and unexpected events can make it challenging for individuals to accurately forecast their future
income. This assumption may not hold true for everyone, especially those in volatile or unpredictable
income situations.

2. Unrealistic assumptions about preferences: The hypothesis assumes that individuals have consistent
preferences over time and that their sole objective is to maintain a stable standard of living. However,
people's preferences and goals can change over their life cycle, making it challenging to capture all the
factors that influence consumption decisions.
3. Neglects other financial goals: The Life Cycle Income Hypothesis focuses primarily on consumption
smoothing and retirement planning. While these are important aspects, individuals often have other
financial goals, such as education expenses, homeownership, or healthcare costs, which may not be
adequately addressed by the hypothesis.

4. Ignores non-income determinants of consumption: The Life Cycle Income Hypothesis primarily
focuses on income as the key determinant of consumption decisions. It tends to overlook the influence
of other factors, such as wealth, interest rates, credit availability, social norms, and psychological
factors, which can significantly impact consumption behavior.

5. Heterogeneity among individuals: The hypothesis assumes a homogeneous population with similar
income patterns and preferences. However, in reality, individuals have diverse income profiles, career
paths, and consumption preferences. This heterogeneity can lead to variations in saving and
consumption behavior that may not be fully captured by the Life Cycle Income Hypothesis.

It is important to consider these limitations when applying the Life Cycle Income Hypothesis in real-
world scenarios. While it provides a useful framework for understanding consumption and saving
behavior, it is necessary to incorporate additional factors and consider individual differences to obtain a
more comprehensive understanding of how individuals manage their finances over their lifetime.

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The permanent income hypothesis, proposed by Milton Friedman in 1957, posits that individuals base
their consumption decisions not solely on their current income, but rather on their expected long-term
average income, also known as their permanent income. According to this theory, individuals are more
likely to adjust their consumption patterns in response to changes in their permanent income rather
than temporary fluctuations in their current income.

The permanent income hypothesis suggests that individuals tend to smooth out their consumption over
time, aiming to maintain a consistent standard of living. For instance, if an individual receives a
temporary increase in income, such as a year-end bonus or a tax refund, they are more likely to save or
invest the additional funds rather than significantly increase their spending. This is because they
perceive the extra income as a one-time windfall, rather than a permanent increase in their overall
income.
Conversely, if an individual experiences a temporary decrease in income, such as a job loss or a pay cut,
they are more likely to dip into their savings or take on debt to maintain their usual level of
consumption. This behavior reflects the belief that the decrease in income is a temporary setback and
that their permanent income will eventually recover.

The permanent income hypothesis also suggests that individuals may adjust their consumption patterns
in response to changes in their expectations about their future income. For example, if individuals
anticipate a future increase in their permanent income, such as a promotion or a career advancement,
they may increase their spending even before the actual increase in income occurs.

Overall, the permanent income hypothesis emphasizes the importance of individuals' long-term income
expectations in shaping their consumption decisions. It suggests that individuals exhibit a certain degree
of forward-looking behavior, smoothing out their consumption patterns to maintain a consistent
standard of living over time.

The Irving Fisher income hypothesis, proposed by the American economist Irving Fisher, suggests that
individuals' consumption patterns are determined by their expected future income levels. According to
this hypothesis, people base their current consumption decisions on their anticipated future income,
rather than solely on their current income.

Fisher argued that individuals have a tendency to smooth out their consumption over time. In other
words, they aim to maintain a relatively stable standard of living by adjusting their spending habits
based on their expectations of future income. For instance, if individuals expect their income to increase
in the future, they may choose to save more and spend less in the present to ensure a higher level of
consumption in the future.

This hypothesis implies that individuals' consumption behavior is forward-looking and rational. It
suggests that people make decisions based on their long-term financial goals and adjust their
consumption accordingly. Additionally, it implies that changes in income expectations can significantly
impact consumption patterns.

The Irving Fisher income hypothesis has important implications for macroeconomic analysis and policy-
making. It suggests that changes in income expectations can influence aggregate demand and economic
growth. For example, if individuals become more optimistic about their future income prospects, they
may increase their current consumption, leading to higher aggregate demand and economic expansion.
Conversely, if income expectations deteriorate, individuals may reduce their consumption, leading to
lower aggregate demand and economic contraction.

However, it is important to note that the Irving Fisher income hypothesis has been subject to criticism
and empirical challenges. Critics argue that individuals' consumption decisions are influenced by various
factors beyond income expectations, such as wealth, credit availability, and social norms. Moreover, the
hypothesis assumes that individuals have perfect foresight and accurate expectations about their future
income, which may not always be the case in reality.

In conclusion, the Irving Fisher income hypothesis proposes that individuals base their current
consumption decisions on their expected future income levels. It suggests that people aim to maintain a
relatively stable standard of living by adjusting their spending habits based on their income
expectations. While this hypothesis has important implications for macroeconomic analysis, it has also
faced criticism and empirical challenges regarding its assumptions and limitations.