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