#Consumption how to#

The permanent income hypothesis omits the detailed treatment of demographics and retirement encompassed in the life-cycle model, focusing instead on the aspects that matter most for macroeconomic analysis, such as predictions about the nature of the consumption function, which relates consumer spending to factors such as income, wealth, interest rates, and the like. Macroeconomists tend to use a simplified version of the optimization framework called the вЂњ permanent income hypothesis,вЂќ whose origins trace back to economist Milton FriedmanвЂ™s treatise A Theory of the Consumption Function (1957). Life-cycle models are most commonly employed by microeconomists modeling household-level data on consumption, income, or wealth. The standard version of the life-cycle model also assumes that consumers would prefer to spend everything before they die (i.e., it assumes there is no bequest motive). The вЂњ life-cycleвЂќ model, first articulated in вЂњ Utility Analysis and the Consumption FunctionвЂќ (1954) by economists Franco Modigliani and Richard Brumberg, proposes that householdsвЂ™ spending decisions are driven by household membersвЂ™ assessments of expenditure needs and income over the remainder of their lives, taking into account predictable events such as a precipitous drop in income at retirement. Within the rational optimization framework, there are two main approaches. In the interest of simplicity, the standard versions of these models also make some less-innocuous assumptions, including assertions that the pleasure yielded by todayвЂ™s consumption does not depend upon on oneвЂ™s past consumption (there are no habits from the past that influence todayвЂ™s consumption) and that current pleasure does not depend upon comparison of oneвЂ™s consumption to the consumption of others (there is no вЂњenvyвЂќ). For example, economists usually assume (1) that the urgency of consumption needs will decline as the level of consumption increases (this is known as a declining marginal utility of consumption), (2) that people prefer to face less rather than more risk in their consumption (people are risk-averse), and (3) that unavoidable uncertainty in future income generates some degree of precautionary saving. This вЂњrational optimizationвЂќ assumption is untestable, however, without additional assumptions about why and how consumers care about their level of consumption therefore consumersвЂ™ preferences are assumed to be captured by a utility function. In their studies of consumption, economists generally draw upon a common theoretical framework by assuming that consumers base their expenditures on a rational and informed assessment of their current and future economic circumstances.

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#Consumption how to#

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