Economics • Economic BasicsHard
What does the 'Permanent Income Hypothesis', formulated by Milton Friedman, suggest about consumer spending behavior?
A. Consumers base their consumption solely on their current disposable income.
B. Consumption is determined by a person's long-term expected or permanent income rather than transitory income.✓ Correct Answer
C. Consumer spending is inversely related to interest rate fluctuations in the short run.
D. Government expenditure crowds out private consumption entirely over a multi-year horizon.
💡 Solution & Explanation
Milton Friedman formulated the Permanent Income Hypothesis, which asserts that individuals base their consumption expenditures on their long-term expected or permanent income rather than fluctuating transitory income. Alternative hypotheses like the Keynesian absolute income model argue that consumption depends strictly on current disposable income. This macroeconomic theory explains why temporary tax cuts often fail to produce a proportional surge in consumer spending.
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