What is the Permanent Income Hypothesis?

This is a hypothesis stating that consumers will spend at a level relative to their expected level of long-term income. The consumer sees a certain level of income as recurring or permanent. 

How is the the Permanent Income Hypothesis Used?

Milton Friedman came up with the permanent income hypothesis in 1957. Consumption spending will be based on consumer expectations about their earnings over a long period. As such, spending habits will change based upon their individual expectations. Expectations will vary based upon how they perceive factors affecting their future earnings. Therefore, policy decisions that affect a consumers perception of long-term earnings will result in increased spending. 

Inflows of capital that are not seen as long-term may result in immediate spending, saving, or investing - depending upon the spending history and liquid assets of the recipient. Individuals will only save money when they earn at a rate above their expected, long-term rate.

Related Topics

• Total utility
• Marginal Utility
• Diminishing Marginal Utility
• Marginal Utility per Dollar
• Rule of Maximizing Utility
• Consumption
• Consumer Goods
• Changes in Income Affect Consumer Choices
• Changes in Price Affect Consumer Choices
• Substitution Effect
• Income Effect
• Budget Constraints Create Demand Curves
• Lifecycle Model of Consumption
• Autonomous Consumption
• Permanent Income Hypothesis
• Lipstick Effect
• Engel's Law
• Consumerism
• Paradox of Thrift
• Ricardo Barro Effect
• Consumer Confidence Index
• The Wealth Effect
• Behavioral Economics