permanent income theory of consumption - aka life cycle theory of consumption
- total wealth = human wealth + nonhuman wealth
- human wealth - after-tax labor income
- nonhuman wealth - financial wealth (total value of stocks, bonds, checking/savings) + housing wealth (value of house minus mortage still due)
- Ct = C(total wealtht)
- would reasonably spend enough each year to keep the consumption level the same throughout life
- level of consumption higher than income >> borrow the difference
- level of consumption lower than income >> save the difference
more realistic consumption trends
- disportionate consumption throughout life
- save more expensive activities for later
- most consumption decisions made for short-term
- long-term rarely planned out this much in advance
- consumption decisions more dependent on current income than overall wealth
- future earnings may be better or worse than expectations
- consumer hesitant to spend more than current income each year
- may not be able to borrow enough to reach desired consumption level
- Ct = C(total wealtht, YLT-Tt)
- YLT-Tt = current after-tax labor income
- expectations affect consumption directly through human wealth (calculated by expectations of future labor income, interest rates, taxes)
- expectations affect consumption indirectly through nonhuman wealth (outside sources directly affect nonhuman wealth by their own expectations of future values)
- consumption usually responds less than 1 for 1 to changes in current income
- consumers don't instantly accept recessions/expansions as long-term changes >> would not drastically change their consumption to match economical changes
- current income doesn't need to change for consumption to change
- more current consumption >> less the consumer can consume in the future
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