Answer to Question #214815 in Macroeconomics for Franklin

Question

Develop a permanent income and adaptive expectations model by permanent life cycle and show its differences from permanent income hypothesis in empirical work analysis?

Answer 1

Based on the life-cycle hypothesis, a person's income will fluctuate throughout his or her life. This indicates that customers will save more when their income is higher and less when their income is lower. Consumption will be determined by wealth and income.

Function of consumption:

C = αW + βY

In the near run, the traditional Keynesian consumption function occurred with fixed wealth.

Human aim at smoothening their consumption rather than focusing on income over a period as suggested by permanent income theory. Individual's incomes fluctuates from yearly in this field.