Absolute income hypothesisFrom Wikipedia, the free encyclopediaJump to: navigation, search This economic theory related article is a stub. You can help Wikipedia by expanding it.

The Absolute Income Hypothesis is theory of consumption proposed by English economist John Maynard Keynes (1883–1946), and has been refined extensively during the 1960s and 1970s, notably by American economist James Tobin (1918–2002).[1]

Contents

[hide] 1 Background 2 Model 3 Notes

4 References

[edit] Background

The theory examines the relationship between income and consumption, and asserts that the consumption level of a household depends on its absolute level (current level) of income. As income rises, the theory asserts, consumption will also rise but not necessarily at the same rate.[2]

Marginal propensity to consume is present in Keynes' consumption theory and determines by what amount consumption will change in response to a change in income.

While this theory has success modeling consumption in the short term, attempts to apply this model over a longer time frame have proven less successful. This has led to the absolute income hypothesis falling out of favor as the consumption model of choice for economists.[3]

[edit] Model

Ct = λYt

Where:

Ct is consumption at time t.

λ is the Marginal propensity to consume (0 < λ < 1)

Yt is income at time t.

Relative income hypothesisFrom Wikipedia, the free encyclopediaJump to: navigation, search

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Developed by James Duesenberry, the relative income hypothesis states that individual’s attitude to consumption and saving is dictated more by his income in relation to others than by abstract standard of living. So an individual is less concerned with absolute level of consumption than by relative levels. The percentage of income consumed by an individual depends on his percentile position within the income distribution.

Secondly it hypothesises that the present consumption is not influenced merely by present levels of absolute and relative income, but also by levels of consumption attained in previous period. It is difficult for a family to reduce a level of consumption once attained. The aggregate ratio of consumption to income is assumed to depend on the level of present income relative to past peak income.

[edit] References

Dusenberry, J. S. Income, Saving and the Theory of Consumer Behaviors. Cambridge: Harvard University Press, 1949.