Question

What is consumption puzzle and consumption smoothing? Write explicitly and briefly

Answer 1

Consumptio smoothing is the economic concept used to express the desire of people to have a stable path of consumption. People desire to translate their consumption from periods of high income to periods of low income to obtain more stability and predictability.

There exists many states of the world, which means there are many possible outcomes that can occur throughout an individual's life. Therefore, to reduce the uncertainty that occurs, people choose to give up some consumption today to prevent against an adverse outcome in the future.

Consumption puzzle was that according to Permanent Income Hypothesis (where consumption depands only on the permanent income of the consumer). APC depends only on the ratio of permanent income to current income.