Answer to Question #260449 in Macroeconomics for Kulshegzy

Question

Permanent Income of consumption is just the average of all current and future incomes. Thus, one does not need to do the maximisation of intertemporal utility”. True or False. Discuss according to the model

Answer 1

Solution:

The statement is False.

 

The permanent income hypothesis is a theory of consumer spending that states that individuals will spend money at a level consistent with their expected long-term average income. The level of expected long-term income thus becomes thought of as the level of permanent income that can be safely spent.

Permanent income of consumption is measured in terms of a weighted average of past incomes.

According to this view, consumption depends on some average value of income rather than on current income. In strong versions of the hypothesis, consumption might depend on the present discounted value of income.

The intuition behind the permanent income result is that consumers wish to smooth their consumption over time through the maximization of intertemporal utility.