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lnc11 - The permanent income hypothesis Milton Friedman...

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The permanent income hypothesis Milton Friedman introduced the concept to explain how people smooth consumption over the vicissitudes of the business cycle. The idea is simple, in typical Chicago School style. Here’s a concise description I cadged from http://ingrimayne.saintjoe.edu/econ/FiscalDead/PermIncome.html The central idea of the permanent-income hypothesis , proposed by Milton Friedman in 1957, is simple: people base consumption on what they consider their "normal" income. In doing this, they attempt to maintain a fairly constant standard of living even though their incomes may vary considerably from month to month or from year to year. As a result, increases and decreases in income that people see as temporary have little effect on their consumption spending. The idea behind the permanent-income hypothesis is that consumption depends on what people expect to earn over a considerable period of time. As in the life-cycle hypothesis, people smooth out fluctuations in income so that they save during periods of unusually high income and dissave during periods of unusually low income. Thus a pre-med student should have a higher level of
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