The permanent income hypothesis (PIH) is a theory of consumption that was developed by the American economist Milton Friedman. In economics consumption is the primary motivating force in the wealth or utility maximizing paradigm An economist is an expert in the Social science of Economics. Milton Friedman (July 31 1912 November 16 2006 was an American Nobel Laureate Economist and Public intellectual. In its simplest form, PIH states that the choices made by consumers regarding their consumption patterns are determined not by current income but by their longer-term income expectations. Consumers refers to individuals or households that use goods and services generated within the economy. The present is the Time that is perceived directly not as a recollection or a speculation In the case of Uncertainty, expectation is what is considered the most likely to happen
Measured income and measured consumption contain a permanent (anticipated and planned) element and a transitory (windfall gain/unexpected) element. Income, refers to consumption opportunity gained by an entity within a specified time frame which is generally expressed in monetary terms A windfall gain (or windfall profit) is any type of Income that is unexpected 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. This article is about proportionality the mathematical relation Income, refers to consumption opportunity gained by an entity within a specified time frame which is generally expressed in monetary terms The marginal propensity to consume (MPC is an observable concept in Economics that measures the increase in personal consumer spending ( consumption) that occurs with Average propensity to consume (APC is the percentage of income spent
In Friedman's permanent income hypothesis model, the key determinant of consumption is an individual's real wealth, not his current real disposable income. Permanent income is determined by a consumer's assets; both physical (shares, bonds, property) and human (education and experience). These influence the consumer's ability to earn income. The consumer can then make an estimation of anticipated lifetime income.
The theory suggests that consumers try to smooth out consumer spending based on their estimates of permanent income. Only if there has been a change in permanent income will there be a change in consumption.
The key conclusion of this theory is that transitory changes in income do not affect long run consumer spending behaviour.
Suppose a government cuts taxes prior to a general election. If consumers perceive this to be only a temporary reduction in their tax burden to increase the government's popularity, then consumption will remain unchanged. If the tax cut is seen as permanent then this may cause increased spending.