Chapter 4R, Problem 1CTQ

To determine

If the permanent hypothesis can be supported by evidence.

Explanation of Solution

The permanent income hypothesis states that people tend to spend and smoothen their consumption based on their expected long-term average income also known as permanent income rather than their current income. This hypothesis is supported by practical evidence. We often see white-collar workers spending more than what they can afford using tools like credit cards. They do these because they understand their high-income potential and foresee a high expected long-term average income. These groups of workers tend to save only when they realize that their current income exceeds their permanent income.