Absolute income hypothesis

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In economics, the absolute income hypothesis concerns how a consumer divides his disposable income between consumption and saving.^[1] It is part of the theory of consumption proposed by economist John Maynard Keynes. The hypothesis was refined extensively during the 1960s and 1970s, notably by American economist James Tobin (1918–2002).^[2]

Background[]

Keynes' General Theory in 1936 identified the relationship between income and consumption as a key macroeconomic relationship. Keynes asserted that real consumption (ie adjusted for inflation) is a function of real disposable income, which is total income net of taxes. As income rises, the theory asserts, consumption will also rise but not necessarily at the same rate.^[2] When applied to a cross section of a population, rich people are expected to consume a lower proportion of their income than poor people.

The marginal propensity to consume is present in Keynes' consumption theory and determines by what amount consumption will change in response to a change in income.

While this theory has success modeling consumption in the short term, attempts to apply this model over a longer time frame have proven less successful. This has led to the absolute income hypothesis falling out of favor as the consumption model of choice for economists.^[3]

Model[]

The model is

${\displaystyle C_{t}=\alpha +\lambda Y_{t}}$

where:

• ${\displaystyle C_{t}}$ is consumption at time t,
• ${\displaystyle \alpha }$ is autonomous consumption, a constant,
• ${\displaystyle \lambda }$ is the marginal propensity to consume (${\displaystyle 0<\lambda <1}$),
• ${\displaystyle Y_{t}}$ is disposable income at time t.

See also[]

• Consumption function

Notes[]

References[]

• Keynes, John M. The General Theory of Employment, Interest and Money. London: Macmillan, 1936.

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