Detailed Economics Report: Exploring the Permanent Income Hypothesis

This report examines the Permanent Income Hypothesis, a theory developed by Milton Friedman, focusing on how individuals make consumption decisions based on their expected lifetime income rather than just their current income. The report discusses the implications of this theory, including the impact of income inequality on consumption behavior, the concept of marginal propensity to consume, and how government policies can influence economic growth. It further explores how factors like financial constraints, unemployment, and recession affect consumption patterns. The analysis highlights the importance of considering future income expectations in financial decision-making and the role of government in addressing economic issues to boost consumption and promote economic growth.

Running head: PERMANENT INCOME HYPOTHESIS
PERMANENT INCOME HYPOTHESIS
Name of the student
Name of the university
Author’s name

1PERMANENT INCOME HYPOTHESIS
The permanent income hypothesis is one of the theory developed by Milton Freidman in
the year 1957. The theory showed that the consumption behaviour are difficult to be predicted.
The consumption behaviour mainly depends on the expectation of the individual that how much
he will earn in future above his average income that he earns. The main concept that Freidman
focused on the consumption behaviour do not depend much on today’s income of an individual
rather it depends on his income earned all over his life.
However, this leads to a question that how inequality of income influences the
consumption behaviour of the individual. For example- if a person has $20 today. His decision of
investing this $ 20 today which is his present income depends on the entire income that he
expects to earn all over his life. $20 is just a meagre sum of his lifetime earnings.
As per the theory, a person should invest more than $20 today because he is going to earn
more than this sum in his life. This raises a question that whether all individual will invest the
given sum on the basis of their expectation of good earning in the future (Lunfang et al., 2018).
The answer of the question lies in the fact that individuals differ on the basis of their
income. Some people are wealthy and some are poor. People who have lower income and less
savings have higher marginal propensity to consume whereas people who have higher income
have lower marginal propensity to consume. The concept also highlights a viewpoint that people
who spends more of their income today becomes poorer and will have less creditworthiness.
They will find difficulty in borrowing funds from financial institution. The consumption
behaviour of the individual will be affected as he will not be able to finance his consumption
needs (Omgba & Djiofack, 2019).

2PERMANENT INCOME HYPOTHESIS
The other implication of the study is the more an individual will spend on his
consumption, the pressure will be on liquid assets. The excessive spending of the liquid assets
will affect the fiscal policy of any nation.
The solution of the problem lies in the hands of the government that how the equality of
income can be maintained among the individual. The government can invests the funds more for
the lower income group. This is because lower income group have higher marginal propensity to
consume. These are the person who will actually spends the money and therefore the
consumption of the economy will increase. This will help in boosting the economic growth
(Keho, 2019).
As per permanent income hypothesis, the individual decision making of the consumption
is largely affected by his expectation of future earnings. If any individual is facing any financial
crunch and unable to pay out his debt, he will naturally minimize his daily consumption
behaviour. People react to the income constraints and this affects their decisions of consumption.
Other economic issues like unemployment, poverty, recession etc., all affects the consumption
behaviour. Government can look into these issues and take steps to solve them. Because if these
are curtailed by the government, most lower income group will automatically increase their
consumption. This will lead the economy towards growth (Perla, Sargent & Stachurski, 2020).

3PERMANENT INCOME HYPOTHESIS
References
Keho, Y. (2019). Myopia, liquidity constraints and private consumption: the case of Cote
d’Ivoire. Cogent Economics & Finance, 7(1), 1608052.
Lunfang, D., Khan, K., Khan, I., & Khan, N. H. (2018). Testing the empirical validity of
permanent income hypothesis and absolute income hypothesis for China. The Empirical
Economics Letters, 17(4), 453-460.
Nelson, E. (2017). Reaffirming the Influence of Perla, J., Sargent, T. J., & Stachurski, J.
(2020)Milton Friedman on UK Economic Policy.
Omgba, L. D., & Djiofack, C. (2019). Does permanent income hypothesis a solution? An
empirical assessment via a dynamic general equilibrium model in developing country.