What does the 'Permanent Income Hypothesis' imply regarding a consumer's marginal propensity to consume (MPC) out of transitory income versus permanent income?

💡 Solution & Explanation

Milton Friedman's Permanent Income Hypothesis postulates that individuals base their consumption on their long-term expected or permanent income rather than current fluctuating earnings. Consequently, the marginal propensity to consume out of permanent income is substantially higher because transitory income is mostly saved. Alternative views like the Keynesian absolute income hypothesis focus entirely on current disposable income. This concept is vital for understanding consumer expenditure patterns in macroeconomic theory.