Describes Different Hypothesis Effects. In 1949, Dusenberry presented relative income theory. The starting point of the theory this that consumption and saving do not depend upon the level of current income.
Relative Income Hypothesis
In other words, spending is related to a family’s relative position in the income distribution of approximately similar families.
- A person’s consumptions depend upon the locality where he resides. If he lives in a locality where other persons are not well off, his consumption will not be very high,
- If a person lives in a posh locality where he will have to maintain his life standard, his consumption will be high.
- A consumer has to compete with the neighbor’s relatives and peoples of his scale. According to his consumption will be higher.
Thus average people’s consumption (APC) depends upon locality. Income and consumption style of others with an individual has to compete.
Accordingly, consumption is not sensitive to current income, rather it depends upon the relative income position of an individual.
If in the same income group, income rises or falls. Consumption remains constant. Consumption changes only if the relative position changes.
When the relative income has not changed, the APC of the average household remains constant over time.
Dusenberry presented psychological support to his hypothesis. He says that people have a desire to copy their neighbors like demonstration effects available in the residents of UDCs (Underdeveloped Countries).
Describes Different Hypothesis Effects, This theory has been presented by monetarist Milton Friedman in 1957. The starting point of this theory is that consumption depends upon permanent income.
Accordingly, a consumer has permanent consumption which depends on his permanent income.
The people whose permanent incomes are constant their consumption may differ becomes of differences in taste and ages.
Friedman says that because of permanent income and permanent consumption the APC will remain constant.
As a result, the APS will also remain constant. He says that people save because they went provide consumption to their families.
But the people with low income prefer present consumption over future consumption. Accordingly, the lower-income groups are expected to consume more as compared with their incomes.
While the higher incomes are expected to save more out of their higher incomes. As a result, the APC and APS will remain constant.
Accordingly, if the permanent incomes of all the families change, there will be no change in consumption and saving ratio.
The life-cycle hypothesis presented an individual who wishes to spread his income in such a way that he could avail an optimal level of consumption over his whole life-time.
The LCH views that on average a person’s income is more in the middle age as compared with his childhood and old-age income.
Therefore, a person saves particularly to produce consumption in old age. This is the essence of the life-cycle theory, that people do not want to consume all that they earned at their early age.
They save and unsaved, so as to consume their lifetime income in the pattern they want.
Thus, they save in the middle age or in the working-age and use these savings to finance spending in their retirement years.
The life-cycle theory is also according to a theory of savings. This theory predicts that people save more when their income is high relative to lifetime average income and unsaved when their income is also relative to the lifetime average.
RIH Differ from PIH and LCH
Describes Different Hypothesis Effects, According to RIH, people have to compete with their friends and relatives, etc., which shows that it is difficult to curtail consumption expenditures.
While PIH and LCH are of the view that people save under certain economic motives they save in order to maintain a smooth consumption style in the future.
From the above discussion, we conclude that RIH analysis the effect of consumers’ habits on consumption, while PIH and LCH explain the economic behavior of a consumer.