Question

Explain the basic concept of the Friedman's permanent income hypothesis. Under what circumstance leisure is considered as a normal good? Under what circumstance leisure is considered as an inferior good? Explain.

Answer 1

FRIEDMAN'S PERMANENT INCOME HYPOTHESIS - Permanent income hypothesis theory is given by MILTON FRIEDMAN in 1957.

• Friedman says that consumption is a function of permanent income.
• He rejects the use of current income as determinant of consumption expenditure.
• He divides both consumption and income into permanent and transitory component.
• According to friedman permanent income depend on partly on current income and partly on previous income.
• According to Friedman short run consumption function is non-proportional  (APC>MPC) and long run consumption function is proportional (APC=MPC).
• He assumes that APC of all families either rich or poor will be same in the long run.
• According to him consumption neither depend on absolute income nor on relative income but on permanent income.

LEISURE IS CONSIDER AS NORMAL GOOD - Leisure is consider as normal good when wages are higher.People start substituting work for leisure.When people are getting more income for less work they start substituting work for leisure.This is because of substitution effect leisurre is consider as normal good.

LEISURE IS CINSIDER AS INFEROIR GOOD - When income of people start declining they start working more and substitute time of leisure in working more in order to earn more.This is because supply of labour increases substituting their leisure time.In this case leisure is consider as inferior good.