Friedman's permanent income hypothesis model, the key determinant of
consumption is an individual's real wealth, not his current real disposable
income. Permanent income is determined by a consumer's assets; both physical
(shares, bonds, property) and human (education and experience). These
influence the consumer's ability to earn income. The consumer can then make
an estimation of anticipated lifetime income.
suggests that consumers try to smooth out consumer spending based on their
estimates of permanent income. Only if there has been a change in permanent
income will there be a change in consumption.
conclusion of this theory is that transitory changes in income do not affect
long run consumer spending behaviour.
government cuts taxes prior to a general election. If consumers perceive this
to be only a temporary reduction in their tax burden to increase the
government's popularity, then consumption will remain unchanged. If the tax
cut is seen as permanent then this may cause increased spending.