Answer to Question #81529 in Macroeconomics for Afifa

Question

Explain why changes in consumption are unpredictable if consumer obey the permanent income hypothesis and have rational expectation

Answer 1

Changes in consumption are unpredictable because consumers have rational expectations and they spend money in levels that are consistent with their long term earning expectations. They receive information about their future changes in levels of their income which is not predictable and they respond by changing their consumption patterns. The consumers tend to adjust their consumption according to the future income expectations.