Chapter 8: Permanent Income Hypothesis and Keynesian Multiplier

Life-Cycle Theory of Consumption

- Consumption is smoother (less up & down) than current income - People look back and forward in time to determine consumption and saving

Permanent Income Hypothesis

- Is a specific Life-cycle theory of consumption - A person's consumption every period equals Permanent Income = average lifetime income (earnings) expected over a person's lifetime - A person's consumption only changes if his/her average income over a lifetime - permanent income - changes. Permanent Income = average lifetime income

Keynesian Multiplier

- The Keynesian multiplier is simply a restatement of the money velocity effect, which we will study later in the course when we study monetary economics. - Basically, it says that there is a snowball effect: some initial spending can snowball into a larger total amount of spending and a larger aggregate demand AD.

Preliminary Concepts

Disposable Income = after tax income = GDP - ... - net taxes Consumption: spending on new goods and services t of disposable income Saving: what is not spent is saved. Saving = investment Consumption + Saving = Disposable Income

Keynesian theory of consumption

people spend a certain fraction of their income