Question

Compare and contrast the "life cycle" hypothesis and the "permanent income" hypothesis. What are their respective implications for inequality in the income distribution?

I answered: Let’s begin by understanding the difference between the life cycle hypothesis and permanent income, we have to understand the life cycle and the permanent income hypothesis.The life-cycle hypothesis (LCH) is an economic theory that describes the spending and saving habits of people throughout a lifetime. The concept was developed by Franco Modigliani and his student Richard Brumberg in the early 1950s.The theory is that individuals seek to smooth consumption throughout their lifetime by borrowing when their income is low and saving when their income is high.The LCH assumes that individuals plan their spending over their lifetimes, taking into account their future income. Accordingly, they take on debt when they are young, assuming future income will enable them to pay it off.They then save during middle age in order to maintain their level of consumption when they retire. A graph of an individual's spending overtime thus shows a hump-shaped pattern in which wealth accumulation is low during youth and old age and high during middle age.The permanent income hypothesis is a theory of consumer spending, stating that people will spend money at a level consistent with their expected long-term average income.The level of expected long-term income then becomes thought of as the level of "permanent" income that can be safely spent. A worker will save only if his or her current income is higher than the anticipated level of permanent income, in order to guard against future declines in income.The permanent income hypothesis was formulated by the Nobel Prize-winning economist Milton Friedman in 1957. The hypothesis implies that changes in consumption behavior are not predictable because they are based on individual expectations.Even if economic policies are successful in increasing income in the economy, the policies may not kick off a multiplier effect from increased consumer spending.Instead, the theory predicts there will not be an uptick in consumer spending until workers reform expectations about their future incomes.It is now clear from the above the difference between the two, so we can conclude that if there is some similarity between the two, then there are some inequalities which we can see as follows:Would it be correct to say that the Permanent Income Hypothesis (PIH) stipulates that current consumption decisions are made based on future income projections/expectations, while the Life-Cycle Hypothesis (LCH) claims that consumption is constant over the average person's lifetime, and this is made possible, despite changes in income level throughout his/her lifetime, through borrowing when younger and savings during the elderly years?This contribution aims to discuss carefully the implications of income inequality and the economic policies to tackle it, especially so because of inequality being one of the leading causes of the 2008 international financial crisis and the "great recession" that subsequently emerged.Wealth inequality is also essential in this respect, but the focus is on income inequality.Ever since the financial crisis and the subsequent "great recession," inequality of income and wealth, has increased and the demand for economic policy initiatives to produce an equal distribution of income and wealth has become more urgent.Reduction would help to increase the level of economic activity as has been demonstrated again more recently. Several economic policy initiatives for this purpose will be the focus of this contribution.

Any edits and corrections?

Answer 1

I have made the necessary correction.

Let’s begin by understanding the difference between the life cycle hypothesis and permanent income, we have to understand the life cycle and the permanent income hypothesis.

The life-cycle hypothesis (LCH) is an economic theory that describes the spending and saving habits of people throughout a lifetime. The concept was developed by Franco Modigliani and his student Richard Brumberg in the early 1950s. The theory is that individuals seek to smooth consumption throughout their lifetime by borrowing when their income is low and saving when their income is high. The LCH assumes that individuals plan their spending over their lifetimes, taking into account their future income. Accordingly, they take on debt when they are young, assuming future income will enable them to pay it off. They then save during middle age to maintain their level of consumption when they retire. A graph of an individual's spending overtime thus shows a hump-shaped pattern in which wealth accumulation is low during youth and old age and high during middle age. The permanent income hypothesis is a theory of consumer spending, stating that people will spend money at a level consistent with their expected long-term average income. The level of expected long-term income then becomes thought of as the level of "permanent" income that can be safely spent. A worker will save only if his or her current income is higher than the anticipated level of permanent income, to guard against future declines in income.

The permanent income hypothesis was formulated by the Nobel Prize-winning economist Milton Friedman in 1957. The hypothesis implies that changes in consumption behavior are not predictable because they are based on individual expectations. Even if economic policies are successful in increasing income in the economy, the policies may not kick off a multiplier effect from increased consumer spending. Instead, the theory predicts there will not be an uptick in consumer spending until workers reform expectations about their future incomes.

It is now clear from the above the difference between the two, so we can conclude that if there is some similarity between the two, then there are some inequalities which we can see as follows: Would it be correct to say that the Permanent Income Hypothesis (PIH) stipulates that current consumption decisions are made based on future income projections/expectations, while the Life-Cycle Hypothesis (LCH) claims that consumption is constant over the average person's lifetime, and this is made possible, despite changes in income level throughout his/her lifetime, through borrowing when younger and savings during the elderly years? This contribution aims to discuss carefully the implications of income inequality and the economic policies to tackle it, especially so because of inequality is one of the leading causes of the 2008 international financial crisis and the "great recession" that subsequently emerged. Wealth inequality is also essential in this respect, but the focus is on income inequality. Ever since the financial crisis and the subsequent "great recession," inequality of income and wealth, has increased and the demand for economic policy initiatives to produce an equal distribution of income and wealth has become more urgent. The reduction would help to increase the level of economic activity as has been demonstrated again more recently. Several economic policy initiatives for this purpose will be the focus of this contribution.