B3 - Milton Friedman

Question 1

How does Friedman’s (1957) Permanent Income Hypothesis complement Modigliani’s approach?

Answer 1

Both argue that current consumption does not depend upon current income alone, contrasting with the Keynesian Consumption Function (KCF).

Question 2

How does the Permanent Income Hypothesis (PIH) differ from the life-cycle approach?

Answer 2

Unlike the life-cycle approach, the PIH allows for non-regular income patterns over the course of a person’s life.

Question 3

What type of income changes does the Permanent Income Hypothesis account for?

Answer 3

The PIH accounts for random and temporary changes in income from year-to-year.

Question 4

How is the Average Propensity to Consume (APC) calculated using the given equation?

Answer 4

APC= C/Y =α(W/Y)+β

Question 5

How does wealth and income variability affect the Average Propensity to Consume (APC) in the short-run and long-run?

Answer 5

• Short-run: Wealth (stock) is less variable than income (flow); therefore, when income (Y) is high, the APC tends to be low.
• Long-run: Wealth and income vary in proportion, leading to a stable ratio of wealth to income (W/Y) and thus a constant APC over time.