The permanent income hypothesis was developed by the American economist Milton Friedman. In its simplest form, the permanent income hypothesis states that the choices consumers make regarding their consumption patterns are determined not by current income but by their longer-term income expectations.

Measured income and measured consumption contain a permanent (anticipated and planned) element and a transitory (windfall/unexpected) element. Friedman concluded that the individual will consume a constant proportion of his/her permanent income; and that low income earners have a higher propensity to consume; and high income earners have a higher transitory element to their income and a lower than average propensity to consume.

References

• M. Friedman, A Theory of the Consumption Function, National Bureau of Economic Research Princeton, N.J., 1957

Economics