Economics • Economic BasicsHard
What is the primary implication of the permanent income hypothesis formulated by Milton Friedman?
A. Current consumption is determined entirely by current disposable income
B. Consumers base their consumption choices on their expected long-term average income✓ Correct Answer
C. Tax reductions funded by government borrowing have no impact on consumer behavior
D. Savings rates decline monotonically as an individual's wealth increases over time
💡 Solution & Explanation
Milton Friedman's permanent income hypothesis posits that individuals base consumption on expected long-run average income rather than volatile fluctuations in current disposable income. The absolute income hypothesis proposed by Keynes argued that current consumption depends strictly on current income. Ricardian equivalence addresses the irrelevance of debt-financed tax cuts versus current taxation. Life cycle hypotheses similarly emphasize smoothing consumption across expected lifetimes rather than reacting to short-term windfalls.
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