Permanent Income Hypothesis

1. Permanent Income Hypothesis

2. Permanent Income Hypothesis • Permanent Income • Temporary Income • Time series data –average permanent income –mpc = 0.9 • Cross section data permanent +temporary income- people with +ve temporary income those who are rich consume relatively smaller portion of their income < 0.9.

3. Permanent Income Hypothesis • People negative temporary income, will consume more than their incomes. They might borrow. • Mpc for cross section income < than 0.9 something like 0.5 to 0.7.

4. Life Cycle Hypothesis • Suggest the diff. way to explain the differences in the estimated mpcs. • During each person life, there are one period when consumes more than he earns and one period consume less than he earn. • Period consumes more-student or early stage of working, income less consume more.

5. Life Cycle Hypothesis • For Example, as a parent- need to support children, Beli Rumah, kereta, mid 20s. • Income more, consumption at steadied level, middle age. • Consume less- retirement group, anak dah sekolah, rumah dah siap, consumption less. However, Income less as well, usually saving will cover their consumption.

6. Life Cycle Hypothesis Tabungan penggunaan Tabungan +ve Tabungan-ve penggunaan dissaving pendapatan Tabungan -ve Masa • muda: Mula bekerja Perbelanjaan tinggi Meminjam/tiada tabungan bersara: Pendapatan kurang/tiada Penggunaan tinggi Tabungan negatif Pertengahan: Kerja Stabil Perbelanjaan rendah Tabungan tinggi

7. Permanent Income Hypothesis & Life Cycle Hypothesis • Permanent income- discounted value of expected future income. • Take into acct in their current consumption decision=- How they do???????? • RM100 today and RM100 in the next year, Which one you prefer?

8. Life Cycle Hypothesis • On average individuals consume only 90% of their income. So the slope of mpc for time series will be 0.9. • Because they don’t know when they will die, and what will happen • Cross sectional data- give a line flatter slope. Because the middle age those had higher income + those with small income yield a line relatively small slope from 0.5 to 0.7

9. Life Cycle Hypothesis • Not b’coz inflation, but because spending RM 100 now can provide immediate benefit, next year give delayed benefit.

10. Discount rate 0.85, calculate present value in next five years, income in 2008 = 100,000

11. Life Cycle Hypothesis • If Y increase 900 , =900/3708.63 or 0.2427. • If this individual received temporary income is only one thousand (1000), not 3708.63, so consumption in 2008 • = 0.2427X1000 which = RM242.7. • Answer the question why consumption not vary as much over time as does income