Question

modern consumption theories argue that consumption is not related to current income but to a longer-term estimate of income and changes in consumption arise from surprise changes in income. discuss.

Answer 1

Modigliani's life cycle theory assumes that individuals try to maximise their lifetime utility,whcih is subjected to a constraint that lifetime consumption should not exceed the lifetime income. In allocationg their consumption over the lifetime, they do it meticulously in such a way that people save more during the period of high income and save less during the period of low income. The life cycle theory also assumes a higher marginal propensity to consume out of permanent income and smaller propensity to consume out of temporary income. Thus an individual'sconsumption function does not depend on the current income but to a longer term estimate of income and changes in consumption arise from surprise changes in income.

An example is that maximum purchasing of electronic and consumer durable items is being done by the individual when he receives his festival bonus or high incentives.