Answer to Question #191780 in Macroeconomics for Julia

Question

Explain how Life-Cycle Hypothesis and the Permanent Income Hypothesis, explain the difference between long run APC and short run APC.

Answer 1

The Life-Cycle Hypothesis is an economic theory that explains how people invest and save money over the course of their lives. It states that people can try to balance their spending during their lives by investing when they have a low income and saving when they have a high income. Permanent Income Hypothesis, on the other hand, states that existing consumption decisions are based on future income projections. Individuals would invest money at a pace that is consistent with their projected long-term average income, according to this theory.

The average tendency to consume (APC) is a measurement of the percentage of total income expended on consumption or the percentage of disposable income not saved. It's determined by dividing total income by consumption. The term "long run APC" refers to an APC that stays constant regardless of income fluctuations. Changes in current income are attributed to changes in permanent income in the long term, so APC remains stable. The APC of the long-run consumption function is constant. The term "short-run APC" refers to an APC that decreases as income increases. The APC falls as income increases because it is the transitory income that shifts in the short run. The APC of the short-run consumption function is decreasing.