Relative income hypothesis

macroeconomics

1. By : Amrina abid Relative income hypothesis

2. Inroduction Since when doubts raised on absolute income theory economists start to find the new relationship between income and consumption. So, in 1949 Dusenberry presented relative income hypothesis. According to this theory, consumption depends on the relative position of the individuals in income scale rather than on the current income.

3. Main points Dusenberry gave following points to setup the theory: Consumption of a person depends upon the locality where he lives. If he lives in a locality where other person’s are not rich his consumption will not be very much high. If a person lives a high standard locality then he will have to maintain his life standard and his consumption will high. Infect, the value of APC changes when living standard on the relative position of the people changes.

4. Short run consumption function It shows non proportional relationship between income and consumption and APC is greater than MPC. Family A Family B Family C Y C APC Y C APC Y C APC 2000 2400 1.2 4000 4000 1 6000 5400 0.8 4000 4800 1.2 8000 8000 1 12000 10800 0.8

5. Graphical representation

6. Long run consumption function Long run shows proportional relationship between income and consumption APC remains constant and equal to MPC. C=CY MPC=APC

7. GRAPHICAL REPRESENTATION

8. Dusenberry’s view According to Dusenberry , it is much easier for a household to adjust the rising income than the falling. as the household’s income rises, his standard of living also rises. More specifically, consumption depends upon only on current income but also depends upon the highest level of income previously earned or previously peaked income. C=f( Y c ,P p Y ) Yc = current income P p Y = previous peak income

9. Criticism by RIT Increase in aggregate level of income always produces a proportional increase in consumption. Consumption behavior is irreversible. It also shows fall in disposable income continuous for a long time the consumer will have to depend upon dissaving.