The Life Cycle Hypothesis
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Keynes’ consumption function, the absolute income hypothesis, revolutionized economics by shifting macroeconomic analysis from the supply side to the demand side. Total demand includes four major components relating to the household, business, government, and foreign sectors — the areas that have attracted varying degrees of scientific research since the post-WWII period. Modigliani’s life cycle hypothesis (LCH) contribution to macroeconomics fits in the domain of household consumption, the only component for which Keynes had advanced a psychological law that “men are disposed, as a rule and on the average to increase their consumption as their income increases, but not by as much as the increase in their income.”1
KeywordsLiquidity Constraint Current Income Consumption Function Permanent Income Income Ratio
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