main theories which provide an explanation for the long-term behavior of consumption by consumers. The theories are not competitive, but, instead, accentuate one another. These two theories are the permanent income hypothesis and the life-cycle hypothesis. The permanent income hypothesis was originated by Milton Friedman in the 1950s, and it theorizes that individuals fix their consumption rates based on their permanent or long-term income and not their present level of income. Even though income levels fluctuate this has little impact on consumption behavior. This is because consumers “will save when income is temporarily high, and use this saving to support consumption when income is temporarily low. Thus overall consumption will be generally constant. This is because of diminishing marginal utility of consuming plenty in one time period, whereas by distributing so as to equate consumption over two time periods, the overall utility will be greater” (Consumption 1). For example, if people get paid once a month, economists do not expect them to spend all their money on the day they are paid, but, instead, expect them to portion it out or consume some of it each day of the month.
With the life-cycle hypothesis we have a theory similar to the permanent income hypothesis. The permanent income hypothesis demonstrates that consumption decisions are based on long-term income, not quarterly or yearly amounts. The life-cycle hypothesis suggests that consumption patterns are based on the length of an individual’s life. While people work and bring in monthly revenue, they will be most likely inclined to save money. Once their income becomes fixed (i.e., retirement), they will more than likely begin to use the monies they have saved for consumption, “The individuals wish to allocate their consumption in the best possible way over the course of their lifetime. They will accumulate assets during the working life, and will b...