Answer to Question #191625 in English for Elizabeth Mulingen

Question

(a)Explain how Life - Cycle Hypothesis and the Permanent Income Hypothesis ,explain the

difference between long run APC and short run APC.

(6)

(b)With a help of a diagram discuss how the permanent income theory of consumption

explains the difference between the cross-sectionandtime-series estimates of the

Keynesian aggregate consumption function.

Answer 1

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.