Economics • Economic BasicsHard

In neoclassical macroeconomic theory, what does the 'Permanent Income Hypothesis' formulated by Milton Friedman assert about consumer spending behavior?

A. Current consumption is determined entirely by current disposable income received during the same period

B. Consumers base their consumption decisions primarily on their anticipated long term average income rather than transitory income fluctuations✓ Correct Answer

C. Aggregate savings remain fixed regardless of interest rate adjustments over business cycles

D. Marginal propensity to consume out of temporary tax rebates equals unity

💡 Solution & Explanation

Milton Friedman's Permanent Income Hypothesis posits that individuals smooth consumption over their lifetime based on expected long term permanent income, treating windfall gains as transitory savings. Keynesian absolute income hypothesis argued that current consumption depends strictly on current income. This theory explains why short term fiscal stimulus packages with temporary tax cuts often yield muted multiplier effects. Life cycle hypothesis by Franco Modigliani complements this view by focusing on wealth accumulation across different age cohorts.

🚩 Report a problem

Practice more Economics Economic Basics questions →

In neoclassical macroeconomic theory, what does the 'Permanent Income Hypothesis' formulated by Milton Friedman assert about consumer spending behavior?

More Economics Economic Basics questions