How do you relate your consumption to your life cycle?

The life-cycle hypothesis (LCH) is an economic theory that describes the spending and saving habits of people over the course of a lifetime. The theory states that individuals seek to smooth consumption throughout their lifetime by borrowing when their income is low and saving when their income is high.

What are the theories of consumption?

The three most important theories of consumption are as follows: 1. Relative Income Theory of Consumption 2. Life Cycle Theory of Consumption 3. Permanent Income Theory of Consumption.

What is the consumption puzzle?

2001, Haider and Stephens 2007 and Schwerdt 2005) found a sharp decline in consumption during the first years of retirement, a phenomenon referred to as the ‘retirement-consumption puzzle’. It is puzzling to economists why households do not plan properly and save enough for an expected fall in income.

What is the difference between life cycle hypothesis and permanent income model of consumption?

The LCH pays more attention to the motives for saving than the PIH does and argues strongly in favour of including wealth as well as income in the consumption function. The PIH, on the other hand, pays more attention to the way in which individuals form expectations about their future incomes than the LCH does.

What is life cycle consumption theory?

Definition: The Life-cycle hypothesis was developed by Franco Modigliani in 1957. The theory states that individuals seek to smooth consumption over the course of a lifetime – borrowing in times of low-income and saving during periods of high income. The graph shows individuals save from the age of 20 to 65.

What are the factors affecting consumption?

Consumption function, in economics, the relationship between consumer spending and the various factors determining it. At the household or family level, these factors may include income, wealth, expectations about the level and riskiness of future income or wealth, interest rates, age, education, and family size.

What are two types of consumption?

According to mainstream economists, only the final purchase of goods and services by individuals constitutes consumption, while other types of expenditure — in particular, fixed investment, intermediate consumption, and government spending — are placed in separate categories (See consumer choice).

What is the drift theory of consumption?

The consumption drift theory is explained in Fig. 3 where CL is the long-run consumption function which shows the proportional relationship between consumption and income as we move along it. CS1 and CS2 are the short-run consumption functions which cut the long-run consumption function CL at points A and B.

What is Keynes psychological law of consumption?

Keynes defines psychological law of consumption in terms of “the fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their …

What is the difference between transitory and permanent income?

Permanent income can be thought of as the average flow of income one expects to receive—in good years income will be above its permanent level and in bad years it will be below its permanent level. This difference between permanent and current income is referred to as transitory income.

What is Behavioral life cycle hypothesis?

Self-control, mental accounting, and framing are incorporated in a behavioral enrichment of the life-cycle theory of saving called the Behavioral Life-Cycle (BLC) hypothesis. Specifically, wealth is assumed to be divided into three mental accounts: current income, current assets, and future income.

Is the life cycle theory of consumption still relevant?

However, Deaton (2005) argues that life-cycle theory is still relevant and still helps members of society to think about the future. This theory suggests that the relationship between income and household consumption can be negative as consumers may save for future consumption.

Who is the inventor of the consumption function?

The life-cycle theory of the consumption function was developed by Franco Modigliani, Alberto Ando and Brumberg.

What was the purpose of Modigliani and Brumberg?

Modigliani and Brumberg (1954) is primarily concerned with the cross-section or microeconomic implications of the theory, while Modigliani and Brumberg (1980) looks at the time-series and macroeconomic implications.

Are there challenges to the theory of consumption?

While there have been many challenges to the theory of consumption through the years, most recently from a coalition of psychologists and economists, the life-cycle hypothesis remains an essential part of economists’ thinking.