Essay on Consumption Hypotheses

Khalid Khan Lasbela University of Agriculture, Water and Marine Sciences, Uthal, Lasbela, Balochistan

Outline of Presentation

INTRODUCTION Background of the Study Statement of the Problem Significance of the Study LITERATURE REVIEW METHODOLOGY DATA

Introduction

Background of the Study According to the simple Keynesian consumption function, consumption depends solely on disposable income in the current period. However, it does not consider individuals’ expected income or and time preference for consumption.

Introduction

Therefore, there are contradictions between the simple Keynesian consumption function and empirical evidence. Friedman’s permanent income hypothesis (PIH) takes into account lifetime income and is more general and better than the Keynesian absolute income hypothesis (AIH). Many economists treat PIH and Life Cycle Hypothesis (LCH) equal.

Introduction

Statement of the Problem Absolute Income Hypothesis Relative Income Hypothesis Permanent Income Hypothesis Life Cycle Income Hypothesis

So, it is important for policy makers that what type of hypothesis is consistent with Pakistan

Introduction

Significances of the Study Consumption expenditure accounts

for approximately sixty percent of GDP in Pakistan.

Critical determinant of aggregate demand.

Consumption is less volatile than investment.

Introduction

Help us in the understanding of business cycle, and second, it is the basic determinant of economic welfare

Counterpart of consumption is saving

Literature Review

The psychological law of consumption generally known as absolute income hypothesis (AIH) introduced by Keynes (1936)

Kuznets (1946) empirical puzzle. Duesenberry (1948) relative income

hypothesis (RIH). Friedman (1957) Permanent Income

Hypothesis s

Literature Review

Modigliani and Brumbergh (1954) Life Cycle Income Hypothesis.

Hall (1978) developed new approach to test consumption hypothesis, he took life cycle permanent income hypothesis and applied rational expectation and he conclude that current consumption is sufficient for estimation of future consumption.

Literature Review

Flavin (1981) tested the Hall REH by simple structural econometric model of consumption.

Campbell and Mankiw (1989) test the PIH they find that about fifty percent of individual’s consumption choices are based on the PIH while the remaining individual’s consumption choices are based on their current income.

Literature Review

Hsich et al. (1994) tested the PIH and AIH for four Asian countries (Korea, Taiwan, Thailand, and India)

Shea (1995) tested the life cycle permanent income hypothesis for U.S economy

Drakos et al. (2002) investigated that the aggregate consumption in Greece used the aggregate data of consumption

Literature Review

Manitsaris (2006) using annual data of fifteen European Union countries and estimate consumption function under the PIH.

Dejuan et al. (2006) tested the PIH for 11 states of West German.

Liu et al. (2007) tested PIH with Hong Kong’s consumption data from 1984 to 2006

Methodology

There are several ways through which we estimate the consumption function. But the standard model is Euler equation approach. The pioneer of testing the PIH under the rational expectation with Euler equation was Hall (1978). Friedman (1947) estimated the permanent income by using the distributive lag of current income. Lucase (1976) postulates that the lags of current income did not explained the current consumption

Methodology

In the response to Lucase (1976) critique, Hall (1978) showed that with out current consumption other variable have no explanatory power to forecast future consumption

HALL’S RANDOM WALK MODEAccording to PIH, it is usually assumed that aggregate consumption represents the individual decision, so the representative individual maximizes

Methodology

Methodology

Methodology

With the help of above equation (5) we will test the permanent and income hypothesis and Absolute income hypothesis for Pakistan, simultaneously.

Methodology

Campbell and Mankiw (1990) Consumption ModelThis model assumes that the proportion of (1-k) individuals are forward looking and satisfy the PIH while a proportion of ( k) follow the “rule of thumb” and consume their current income.

Structure of Estimations

Testing AIH and PIH at Macro level Testing AIH and PIH at Micro level Testing AIH and PIH for Urban

Households and Rural Households

Sources of Data

The data of the following variables are extracted from the international financial statistics and Household Integrated Economic

  Survey (HIES) Private consumption Income( GDP) Real interest rate Individual’s income Individual's consumption

Thanks