Answer to Question #244030 in Microeconomics for Dilini

Question

Make a comparative assessment of the consumption behavioral theories of life cycle hypothesis and the permanent income hypothesis

Answer 1

Solution:

The life cycle hypothesis is a theory that states that individuals seek to smooth consumption throughout their lifetime by borrowing when their income is low and saving when their income is high.

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

 

The life cycle hypothesis pays more attention to the motives for saving than PIH does and argues strongly in favor of including wealth as well as income in the consumption function.

The permanent income hypothesis, on the other hand, emphasizes more to the way in which individuals form expectations about their future incomes than the LCH does.