What does the 'Permanent Income Hypothesis' formulated by Milton Friedman suggest about the Marginal Propensity to Consume (MPC) out of transitory income?

💡 Solution & Explanation

Milton Friedman formulated the Permanent Income Hypothesis in 1957, stating that current consumption is determined by permanent rather than transitory income, resulting in an MPC out of transitory income close to zero. Unlike traditional Keynesian theories that rely heavily on current disposable income, this hypothesis separates income into permanent and temporary components. Franco Modigliani's Life Cycle Hypothesis is another major consumption theory that complements this concept.