Question

8. Which of the following facts are consistent with forward-looking theories (LCH, PIH, and Random Walk) of consumption? Which are not? Justify your answer in each case. Where the facts are not consistent, can you suggest some alternative explanation? a. The MPC out of current income is less for old people than for middle-aged people. b. The MPC out of current income is less for farmers than for most of other occupations. c. The amount in wealth in the economy is far greater than what current wage eamers will consume in their retirement d. Across the population as a whole, people with lower incomes have lower saving rates than people with higher incomes.

Answer 1

Here is the explanation:

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.

In truth, current labour income enters the life cycle consumption function to reflect expectations of future income. At the same time, the more detailed analysis of the determinants of expected future income that is provided by the PIH can be, and has been, included in the life cycle consumption function.

Friedman’s model is somewhat less satisfactory than the Ando-Modigliani model in that assets are only implicitly taken into account as a determinant of permanent income.

In addition, it relies on the observable aspects of income — ‘permanent income’ and ‘transitory income’ — that the Ando-Modigliani model, which separates out the observable components — labour income and value of assets.

Moreover Friedman’s model explains both the cross-sectional budget studies and short- run cyclical observations that indicate MPC < APC and the long-run observation that the C/Y ratio is fairly constant, that is, APC = MPC.

Random walk- past data cannot be used to predict future share Price.

So By Explain, This is Answer.