Question

According to the permanent income hypothesis,

	a.	consumption responds only to changes in current income
	b.	consumption responds more to expected future changes in income than to current income
	c.	consumption responds more to temporary changes in income than to permanent changes
	d.	consumption responds more to lifetime income than to current income
	e.	consumption is a function of previous income

Answer 1

Answer: b

This is the spending attitude of consumers, which changes as the expected future income changes. Such expected future income indicates permanent income that plays in the mind of consumers while they spend. Current income becomes immaterial here.

Example: Suppose a worker gets good income now but he knows after few months his income will drop because of lean period (there will be less work and less income). The worker will spend less today and will try to save more money for future uncertainties.