Economics • Economic BasicsHard
What does the 'Permanent Income Hypothesis' formulated by Milton Friedman state regarding consumer spending behavior?
A. Consumption depends entirely on current disposable income received in the present period
B. Consumption is determined by expected long-term average income rather than transitory income fluctuations✓ Correct Answer
C. Savings rates decline to zero as household net worth increases over time
D. Marginal propensity to consume out of temporary windfalls is always equal to one
💡 Solution & Explanation
Friedman's permanent income hypothesis posits that individuals base their consumption choices on their expected long-term average income rather than temporary or transitory income changes. Consequently, unexpected windfalls are largely saved rather than consumed immediately. Alternative choices describe the classical Keynesian absolute income hypothesis. This theory explains why short-term tax rebates often fail to stimulate consumer spending significantly.
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