Author Question: Explain the permanent-income hypothesis and the life-cycle hypothesis. How are these hypotheses ... (Read 44 times)

misspop · **on:** Jun 30, 2018

Explain the permanent-income hypothesis and the life-cycle hypothesis. How are these hypotheses similar?

What will be an ideal response?

Question 2

If the public believes the commitment to a nominal anchor to be credible, the effect of a negative aggregate demand shock is for ________.

A) short-run aggregate supply to shift up
B) short-run aggregate supply to be unaffected
C) short-run aggregate supply to shift down
D) inflation, but not economic activity, to decrease

ndhahbi · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

The permanent-income hypothesis was developed by Milton Friedman to explain consumption smoothing. According to this hypothesis, household consumption depends on permanent income, and households use financial markets to save and borrow to smooth consumption in response to fluctuations in transitory income. Friedman argued that the level of consumption depends only on the level of permanent income.
The life-cycle hypothesis was developed in part by Franco Modigliani to explain consumption smoothing. According to the life-cycle hypothesis, households use financial markets to borrow and save to transfer funds from periods when income is high, such as their working years, to periods when income is low, such as their retirement years, periods of unemployment, or years spent in college as a student.
Both hypotheses are used to explain consumption smoothing, and assume that households prefer to smooth consumption over time.

Answer to Question 2

B