Economics Dictionary of ArgumentsHome
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| Permanent Income Hypothesis: The Permanent Income Hypothesis, developed by Milton Friedman, suggests that people base their consumption not on current income but on their expected long-term average income. Temporary income changes have little effect on spending, while changes in expected permanent income significantly influence consumption behavior. See also Income, Inflation, Saving, Consumption._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Milton Friedman on Permanent Income Hypothesis - Dictionary of Arguments
Landsburg I 8 Permanent Income Hypothesis/Friedman/Landsburg: Friedman hypothesized that: A) When your permanent income rises by, say, $ 100 a year, you'll typically increase your annual spending by something very close to $ 100.* B) When your non-permanent income rises or falls by $ 100 in a given year (because of an unexpected bonus at work, a lost wallet, a winning scratch-off ticket, or an illness) then you'll typically make only a small adjustment in your current spending. If Alice out-earns Bob by $ 100 a year, then (for an average Alice and an average Bob) it's usually because her permanent income exceeds his by about $ 90 and her non-permanent income exceeds his by $ 10. Therefore, since only her permanent income affects her spending, she outspends him by about $90. Landsburg I 9 Problem/FriedmanVsKeynes: Therefore it's very easy for an economist to notice that when Alice out-earns Bob by $ 100, She outspends him by $ 90 -while remaining entirely oblivious to what lies behind the numbers. In particular, that economist can easily make the mistake of believing that a $ 100 increase in non-permanent income can lead to a $90 increase in spending. But that inference, which underlies the entire theory of the Keynesian multiplier, is wrong. Cf. >Investment multiplier/Keynes. Permanent/income vs. absolute income: The permanent income hypothesis also settles a nagging riddle that had been troubling economists for a long time. Example: a) If Alice earns $ 20,000 more than her neighbour Bob, she typically outspends him by about $ 18,000. b) But if Alice earns $ 20,000 more than her grandfather did at her age, she typically outspends him by almost the full $ 20,000. (We see this in real-world data.) Whence the discrepancy? Solution: When Alice out-earns Bob, it's often partly because she's having an unusually good Year. Unusually good years don't generally repeat themselves. So if she out-earns Bob by $ 20,000, she might expect to out-earn him by only about $ 18,000 going forward, and increases her spending by almost that amount. But when Alice out-earns her grandfather, it's likely to be because times have changed. That's a permanent condition. She expects to continue out-earning him by about the same amount forever, and spends accordingly. Landburg I 10 Confirmations of the hypothesis: Friedman proposed several tests. For example: farmers' income is heavily dependent on market and weather conditions (this was especially true in Friedman's time, when farmers didn't routinely hedge their bets through futures markets). Factory workers' income is far more predictable. So an upward spike in Frank the farmer's income is likely to be mostly temporary, whereas an upward spike in Mary the machinist's income is likely to be mostly permanent (maybe she got promoted!). Therefore we should (on average of course) see machinists with income spikes increasing their spending by more than farmers with income spikes. Real world data confirm this prediction. Friedman carried out a great many such tests, comparing not just farmers versus machinists, but Swedes versus Englishmen, black Americans versus white Americans, young people versus old people, and more. The results in each case are consistent With the permanent income hypothesis. *Exactly how close depends on a variety of factors including the interest rate and how much you've already got in the bank._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Econ Fried I Milton Friedman The role of monetary policy 1968 Landsburg I Steven E. Landsburg The Essential Milton Friedman Vancouver: Fraser Institute 2019 |
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