Permanent income hypothesis states that consumption is based on permanent income rather than current income. Permanent income refers to income that is expected to persist in the future, while transitory income does not persist. According to the hypothesis, people smooth consumption in response to transitory income variations by using savings and borrowing. The hypothesis assumes tastes and interest rates remain stable over time. In the short run, the consumption function shows consumption is less proportional to income than in the long run, where proportionality is achieved through savings adjustments. Critics argue the hypothesis ignores differences in preferences between rich and poor and does not account for effects of windfalls on consumption.

1. PERMANENT INCOME
HYPOTHESIS
Amrina abid

2. Introduction
■ In 1957 Milton friedman presented it in his book “The theory of consumption”.
■ Friedman permanent theory use irving theory of consumption to rgue that
consumption depend on current income.
■ Through this theory people experience random temporary changes in their income
from year to year.
■ According to Friedman, this theory consist of two components.One is permanent
income and other is transitory income.

3. Definition
■ Permanent income: permanent income means the income that expect to persist into future. ( normal
income compare with transitory income ). Denoted as: Yp
■ Transitory income: transitory income is that part of income that people do not expect to persist in
future. Denoted as: Yt
■ Permanent income hypothesis: according t this theory people choose consumption based on
permanent income and use saving and borrowing to smooth consumption in response transitory
variation in income.
General form of Friedman equation: Cp=f(k,I,Pv,T,Y)
K= showing ratio of C&Y
i= rate of interest
Pv= present value of human and non human value
T= taste of the people
Yp= permanent income

4. Assumptions
■ Slope of budget line depends on the rate of interest.
■ He assumed that real rate of interest remain stable overtime.
■ Taste of consumer remains the same.
■ The preference between present and the future income remains the same.

5. Short run consumption function
(SRCF)
■ Short run consumption function shows non proportional relationship between income
and consumption
■ MPC is less thanAPC.
■ There also exist concept of measured income.
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6. Long run consumption function
(LRCF)
■ According to Friedman, LRCF shows proportional relationship between income and
consumption.
■ APC remains constant and equal to MPC.
■ LRCF lies below the 45 line whichAPC is less than 1.
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7. Criticism
■ APC of rich and poor is not the same because the preferences or desires for the
present consumption amongst the poor are stronger than the future consumption..
■ It is not proper to assume that consumption is not affected by wind fall gains and
losses
■ AsThomas Mayon point out that these tests are invalid because they do not
distinguish between consumption ofYt and consumption ofYo thatY produces.