Report on Consumption Behavior Analysis
Subject: Business, Organizational Behavior | Topics:

The origin of the report:

This report on “Consumption Behavior” has been prepared as a part of our course F-203 Macroeconomics. This report is prepared on the consumption behavior of the families of our group members. Our course instructor M. Masud Rahman has assigned us this report. Here we had to conduct and analysis on the consumption behavior of our family and find out what influences the amount of income devoted to consumption. First our group members had to analyze their individual family’s consumption behavior on the basis of four hypotheses regarding consumption. Then we had to make a comparison of the consumption behaviors among our individual families.

Objectives:

The main objective of preparing the report is to fulfill the requirement of our course instructor. The other objectives behind this study are as follows—

To find out to what extent a family’s consumption depends on income.
To find out what factors influence the consumption of a family.
To justify the effectiveness of the four hypotheses made on consumer behavior.
To have a more clear idea about the knowledge we got from the book.
To draw a comparable picture of the theoretical knowledge and the practical application.

Methodology:

It is a study report in nature. Here, we have studied the consumption behavior of our own family. First, we have collected data regarding the income and consumption of our family. Here one of us has done the analysis on the basis of last five year’s data. The other four of us could not collect five years data, so, they done their analysis based on the data of last three years. The actual data about all expenditures could not be collected. We had to make estimation of some of the expenditures. The data regarding income is almost accurate. After collecting the data about yearly income and expenditure, we have studied the change in consumption and income. We tried to find out the relation between the change in consumption and the change in income. We tried to find out whether the amount of consumption depends on income or not. We also tried to find out what other factors influence the amount of consumption. We then compared our consumption behavior with the arguments of the four hypotheses regarding consumption. The four hypotheses are—

Absolute income hypothesis
Relative income hypothesis
Permanent income hypothesis
Life cycle hypothesis

We have calculated the APC and MPC and then compared them with the arguments of the four hypotheses. We tried to find out which hypothesis is best fitted to our consumption behavior. We also tried to find out what other factors affect the consumption besides the factors suggested by the hypotheses. After analyzing the consumption of our families individually, we have compared the results of our analysis to each other. We have gathered the income and consumption of one period of all of our family and plotted a graph. From that graph and the compared data, we again justified the effectiveness of the four hypotheses. We showed the income and consumption trend of different income levels and tried to find out which hypothesis is consistent with the trend.

Thus we have prepared an analysis on the consumption behavior of our family. We have divided our report into eight chapters. This is the first chapter of our report. In this first chapter we have furnished the introduction of the report. From Chapter – 2 to Chapter – 6 includes the individual analyses of the five of our group members. In these chapters we have analyzed the income and consumption of our family individually. After showing the individual analyses in these chapters, in Chapter – 7 we made a comparison of the five analyses done by our group members. And at last in Chapter – 8, we have drawn a conclusion of our whole analysis.

Limitations:

While preparing the report we faced some limitations. The limitations are as follows—

• All the information needed for making a complete analysis was not available.

• We could not gather the accurate amounts of the expenditures because our parents do not keep any detailed information about their yearly expenditures. So, we had to make some estimates.

• For finding out the actual trend of consumption and its relation with the change in income, we needed the income and consumption data of many periods. But we could not collect the data of so many periods, and we had to do our analysis on the basis of only three to five years.

• To do our analysis on more details, we need to use various statistical tools. But as we don’t have much knowledge of statistics and we have not completed our statistics course yet, we could not use any statistical tools.

• We have to offset with the quality due to time constraint.

• The analysis is based on some limited data, so it has become difficult to draw a complete figure.

________________________

Prepared by—

Israt Binte Salim
Roll – 12-033

There are four hypotheses regarding consumption behavior suggested by different economist. Here the consumption behavior of a family will be analyzed on the basis of these four hypotheses.

The Income and Consumption pattern:

Here for the analyses I have used the consumption and income of Mr. Abdul Hannan and his family. Mr. Abdul Hannan is a service holder working in the marine field. At present he is working as the captain of a ship in a foreign company. His monthly income comes from his human and nonhuman wealth. His human wealth is his qualification and training in his marine field. His non human wealth is a building from which he receives a monthly rent. He makes the expenditure for him and his family from the income of this two sources. Below are the income and consumption expenditure of his family during the last five years—

Measured Income:

Year Monthly salary Monthly rent Total
2003 50,000×12 10,000×12 7,20,000
2004 50,000×5+90,000×7 10,000×12 10,00,000
2005 90,000×12 10,000×12 12,00,000
2006 90,000×2+1,20,000×10 10,000×12 15,00,000
2007 1,20,000×3+0 20,000×12 6,00,000

Description of the measured income:

In year 2003, Mr. Abdul Hannan was doing a job in a company of Bangladesh for a number of years. There his monthly salary was Tk. 50,000. In that time the building had only one floor and the monthly received rent was Tk. 10,000.

In year 2004, Mr. Abdul Hannan did a course in the marine academy and thus increased his qualification in his field. For the increased qualification, he got a job in a foreign company in June 2004, and there his salary was 90,000 in Taka.

In year 2006, he got a better job offer from another foreign company. In March 2006, he joined that new job and there his salary was 1,20,000 in Taka. In November he started the construction of another floor of his building.

In year 2007, the construction of another floor of his building was complete and his income from rent increased from 10,000 to 20,000. But at April 2007, when he was on leave, he got sick and could not go abroad for his job. So, his income from salary became zero.

Permanent income:

Here we will also consider the permanent income, because according to Milton Friedman, real income is divided into permanent income and transitory income. The permanent income of a person comes from his or her perception of his future income flow and it must be backed by a logic or argument and transitory income is the income which is not certain. So, here is the permanent income of Mr. Abdul Hannan, taken from his perception about his income flow.

Description of the permanent income:

Till year 2003, Mr. Abdul Hannan’s salary has been 50,000 Taka for a long time. So, he regarded this 50,000 as his permanent income. The income from rent Tk. 10,000 was also regarded as permanent by him because he expected the same income from the one floor building in the following years. So, in 2003, he had zero transitory income.

In year 2004, he increased his qualification or his human wealth and thus his expectation of future income increased. After getting the job in abroad with Tk. 90,000 salary, he expected his income from salary to be at least 90,000 in the following years. That’s why his permanent income increased.

In year 2006, though his income from salary increased because of the better job offer, his permanent income did not increase. Because it was an unexpected opportunity for him and he did not expect such a high salary from his human wealth. So, he was not sure of having the same income flow in future and thus his perception of permanent income remained at 90,000 Taka. Thus he had a positive transitory income.

In year 2007, though his income from salary became zero because of his illness, his permanent income did not decrease. Because, it is an unexpected incident and he does not expect to be sick in the following year. Thus he had a negative transitory income in 2007.

Permanent consumption:

Here we have also considered the permanent consumption, because Milton Friedman divides consumption into permanent and transitory consumption. Permanent consumption of a person is the long term perception of his or her consumption and standard of living and transitory consumption is the difference of real or measured consumption from permanent consumption.

Description of permanent consumption:

When his perception about his total monthly income, both from salary and rent, was Tk.60,000 (50,000+10,000), his permanent consumption was Tk.25,000. When his perception about his total monthly income increased from Tk.60,000 to Tk.1,00,000 (90,000+10,000), his living standard increased and he felt free to spend on an average Tk.40,000 monthly. As he felt like spending more monthly, his perception of his monthly expenditure and standard of living increased and thus his permanent consumption has increased. When his perception about his permanent income increased again to Tk.1,10,000, his permanent consumption also increased to 42,000.

Measured consumption:

The actual data about the consumption of the last years could not be collected. That’s why the figures of measured consumption have been estimated on the basis of permanent consumption. Only some major fluctuations of real consumption from permanent consumption, that Mr. Hannan could remember, has been added to the figures of permanent consumption.

Description of measured consumption:

The yearly data of measured consumption has been taken from the yearly total of permanent consumption. The data of all the differences of real consumption from permanent consumption, or all the transitory consumptions, was not available.

Only some major differences have been added with the amounts of permanent consumption. Such as—

In 2004, when the income increased the permanent consumption also increased. But the actual consumption can not be increased immediately. After the increase in income, the real consumption increased gradually. After the income increase in 2004, Mr. Hannan purchased a car and then shifted to a new house in an expensive area and thus his monthly expenditure increased day by day. So, the increase in monthly consumption of year 2004 was approximately Tk.8000 on an average. Thus the total yearly expenditure increased by around 50,000 Taka. Thus in 2004, he had a negative transitory consumption.

In 2006, Mr. Hannan had to spend Tk.6,00,000 for his son’s marriage. It caused a positive transitory consumption.

In 2007, Mr. Hannan was sick and hospitalized. It caused an unexpected expenditure of Tk.50,000 in that year. Thus in 2005, he had a positive transitory consumption.

The expenditure for durable goods has been excluded from the figures of consumption according to Friedman’s definition of consumption, that consumption excludes spending that adds to a family’s stock of durable goods.

Discussion based on the hypotheses:

The Absolute Income Hypothesis:

According to the absolute income hypothesis, an individual consumer’s fraction of consumption from his current income depends on the absolute level of that income. The consumption changes absolutely with the change of income. The hypothesis says that consumption depends on the absolute level of income and consumption of a particular period can be determined from the absolute amount of income of that period. But in the case of our family, we see that the actual consumption does not depend on the absolute amount of income. The hypothesis also says that as income increases, APC goes down. But here the APC does not decrease with the increase in income. Below the measured income, measured consumption and APC are shown together—

Here we can see the actual consumption does not depend on the absolute level of income. Sometimes income is low but consumption is high and sometimes income is high but consumption is low, sometimes the change in consumption relative to the change in income is lower and sometimes it is higher. There is no defined relation between income and consumption. so, the consumption behavior of this family does not fit the Absolute Income Hypothesis.

The hypothesis that fits best:

The consumption behavior of this family most fits with the Permanent Income Hypothesis suggested by Milton Friedman. Because we see that the measured or real income does not have any clear relation with the measured consumption, but the permanent income has a close relation with permanent consumption.

According to permanent income hypothesis, permanent income of a family is the long term perception of that family regarding its income, depending on its farsightedness. So, here I have taken the figures of permanent income from Mr. Abdul Hannan’s expected or perceived value of his income. He arrives at an approximation of his permanent income on the basis of his human and non-human wealth.

There is also a technical approach of measuring permanent income. That is—
Each person looks ahead as best he or she can and derives estimates of the streams of income to be received from human and non human capital. The sum of the present discounted values of these two streams of income constitutes the person’s current wealth. Finally, the figure for his or her permanent income for the current year is equal to that wealth figure multiplied by a rate of interest.

But this approach does not match to the case of this family, because Mr. Hannan does not make any such calculation before making estimation of his permanent income. It comes from his perception and expectation that is made depending on his current income, current human and non human wealth and farsightedness. From one period to the next, his permanent income changes in response to his evaluation of the future flows from human and non human capital.

Similarities:

According to permanent income hypothesis, a family’s measured income is divided into permanent income and transitory income. A family’s measured income in any particular year can be larger or smaller than its permanent income and the transitory income can be positive or negative depending on the difference between the measured income and permanent income. In the case of our family we can see the income pattern is exactly like this. Here, in different times the yearly measured income of this family is larger or smaller than its yearly permanent income. In year 2006, it had a positive transitory income for the unexpected increase in Mr. Hannan’s salary and in year 2007, it had a negative transitory income for his illness.

The hypothesis also divides measured consumption into permanent and transitory components. As with measured income, a family’s measured consumption in any particular year can be larger or smaller than its permanent consumption and the transitory consumption can be positive or negative depending on the difference between the two. The consumption behavior of our family matches with it. It had negative transitory consumption in year 2004 and positive transitory consumption in 2006 and 2007.

The basic argument of Permanent Income Hypothesis is that— the permanent consumption depends on permanent income, only this relationship is true and no other relation between income and consumption is true.

That means—

Cp = f(Yp)
Ct ≠ f(Yp)
Cp ≠ f(Yt)
Ct ≠ f(Yt)

When,
Cp = Permanent Consumption
Ct = Transitory Consumption
Yp = Permanent Income
Yt = Transitory Income

The four elements are shown here—

In the table, we can see only the Cp has a positive relation with Yp. Cp changes with the change of Yp. But the Cp does not change with Y¬t and the Ct does not change with Yp or Yt. so, only the relation between permanent consumption and permanent income can be defined but none of the other relations can be defined.

Dissimilarities:

According to the Permanent Income Hypothesis, the APC of families at all levels of family income is held to be the same when the APC is expressed as a ratio of permanent consumption to permanent income. But, in this family, we can see that the APC is not the same at all levels of income.

Here we can see the APC decreases gradually. Because the family’s permanent consumption is not a constant proportion of its permanent income, in lower level of income it is a larger proportion and in higher level of income it is a smaller proportion. As the family moves to higher income it consumes a smaller proportion and saves a larger proportion of income. So, the consumption behavior of this family disagrees with the permanent income hypothesis in this point.

The Relative Income Hypothesis:

The gradual decrease in the APC of our family can be justified to an extent by the argument of Relative Income Hypothesis suggested by James Dusemberry. This hypothesis argues that the fraction of a family’s income devoted to consumption depends on the level of its income relative to the income of other families with which it identifies. In other words a family’s consumption depends on its relative position in the society to which it belongs. A family will spend a larger fraction of income if it lives in a community where, that income is relatively low and it feels that its relative position in the community is low. And a family will spend a smaller proportion of its income, if that income is relatively high in its community and if it feels its relative position is high in the community. So, when a family’s income rises but the incomes of other families in the community remains unchanged, then its relative position in the community rises and so, it consumes a smaller fraction of its income than it did before.

The consumption behavior of our family can be matched with this argument. When the relative income of the family was low, it consumed a larger fraction of its income. But as the income rises, the relative position of the family becomes higher and it consumes a smaller fraction of its income than it did before. Thus the APC of the family decreases as the level of income increases.

This does not mean that the Relative Income Hypothesis fits the consumption behavior of our family more than the Permanent Income Hypothesis. Because, the above argument became true when we considered the permanent income and the permanent consumption, if we have considered the real or actual income and consumption then it would not have been true. As the Relative Income Hypothesis does not suggest the division of income and consumption to permanent and transitory, this hypothesis does not completely fit with the consumption behavior of our family.

Life Cycle Hypothesis:

The Life Cycle Hypothesis developed by Franko Modigliani, says that the consumption not only depends on income but also on age bracket. An individual’s consumption behavior is different at different stage of his life.

Here, if I had the data of the income and consumption of Mr. Abdul Hannan during his whole life, I could have shown that his consumption pattern matches with the life cycle hypothesis. The hypothesis says that, an individual consumes more than his income in the early years of his life. In the middle age or the middle years of his working life his income exceeds his consumption and he saves for future. Finally in the late years his consumption again exceeds his income. This argument can be matched with the consumption pattern of Mr. Abdul Hannan. Because if we could look back to the early ages of his life, we could have seen that his consumption was more than his income. The data we have here is the data of five years of his middle age. That’s why his consumption is less than his income and he saves the rest for the future. And in the late years of his life or after his retirement, his income will decline and he will consume more than his income and make dissavings from his accumulated savings during these middle years. Thus the consumption behavior of Mr. Abdul Hannan agrees with the argument of the Life Cycle Hypothesis.

Other factors:

The consumption behavior could not be defined with an equation of a straight line. The consumption could not be defined as a function of income, because consumption does not depend on income only. It depends on relative income and age bracket also. None of the four hypotheses exactly fits with the consumption behavior of our family.

Assuming that, the family consists of four members. The parents are service holder and the children are students. And the furnished incomes and expenditures are of three months for a period. Most of the incomes and expenditures are regular.

Now, we discuss four hypotheses to analyze our data—

The Absolute Income Hypotheses:

This hypothesis was made by John Maynard Keynes which says that the individual consumers determine the fraction of current income he will devote to consumption on the absolute level of that income. All things being equal, a rise in absolute income will increase the consumption but lead to decrease in the fraction of that income devoted to consumption. And the MPC remains the same but the APC decreases.

This analysis was made by Keynes but subsequent development was primarily associated with James Tobin and Arthur Smithies.

If we analyze our data to compare with absolute income hypothesis we can see the following features:-

In 2006 income increases from 480000 to 530000 and in 2007 income increases from Tk.5,30,000 to 5,60,000. And the expenditure increases from 3,60,000 to 3,80,000 in 2006 and from 380000 to 390000 in 2007. And the APC of first period is 0.75, the second period is 0.71 and the last period is 0.69. But the MPC also decreases from 0.40 to 0.33 in 2007. So if we compare with absolute income hypothesis, we can see that the presented data does not match with this hypothesis. Because according to this hypothesis, APC goes down gradually but MPC remains same. But in our data MPC decreases. So, we can say that in this case Absolute Income Hypothesis is not true.

Relative Income Hypothesis:

This hypothesis is made by J. S. Dusenbarry. It says that – the fraction of a family’s income devoted to consumption depends on the level of its income related to the income of other families with which it identifies rather than the absolute level of its income.

In a relative income hypothesis, if a family’s income remains unchanged but the incomes of these other families rise, its income position relative to other families has changed and it begins to consume a larger fraction of income than before. And if the relative income of a family increases with no change in the income of the other families in the community then it consumption does not increase as much as absolute income hypothesis suggests.

In our case, the income increases by Tk.50,000 and expenditure by 20,000 in 2006. But in 2007 the income increases by 30000 but the expenditure increases by 10000. Thus the MPC decreases from 0.40 to 0.33. Thus the family’s consumption does not increase as much as the increase in income and the family consumes less from its income as its income increases. It happens because the family tends to match with the consumption behavior of the society to which it belongs to. That’s why I think the consumption behavior of this family matches with the relative income hypothesis.

Permanent income Hypothesis:

Permanent income hypothesis, in according to Milton Friedman, says that, income is divided into two types- permanent and transitory. Consumption also divided into two types.

Here, permanent means, expected income and consumption and transitory means, which occurs suddenly. This hypothesis says that-

Cp = f(Yp)
Ct ≠ f(Yp)
Cp ≠ f(Yt)
Ct ≠ f(Yt)

When,
Cp = Permanent Consumption
Ct = Transitory Consumption
Yp = Permanent Income
Yt = Transitory Income

This hypothesis does not match with this family. Because this family does not make its consumption depending on the expectation of its income in the future years, but it makes the consumption depending on the real or actual income.

The life-Cycle Hypothesis:

This hypothesis, which has been put forward by Franco Modigliani, Richard E. Brumberg and Albert Ando, says that income equals to consumption through out the whole life-cycle.

That is – individual makes dissavings at first and at the end of the life and in the middle age he makes savings. At first, when dissavings occurred income is lower than when dissavings occurs at the end of the life. In the middle age individual repay the loan which he made at first.

In our case, the parents at first, when they were young maintain their life with the help of their parents and their parents are old and they help their parents now. Moreover, they also make savings. From this aspect the life cycle hypothesis has matching with our case.

Prepared by—

Nazia Mahmuda
Roll – 12-077

Consumption analysis of Mohammad Ullah Khan and his family

Our family consists of four members. Mohammad Ullah Khan is the only earning member of our family and other members are dependent on him. The object of this analysis is to analyze the consumption behavior of our family according to four hypotheses of economics. Each of these four hypotheses involves a quite specific but different view of consumer behavior-that is, each assigns a different view role to income as an influence on consumer spending. The four hypotheses are-

1. Absolute income hypothesis
2. Relative income hypothesis
3. Permanent income hypothesis
4. The life cycle hypothesis

The income, consumption, and savings of our family from 2005 to 2007 are given below:

Income of our family:

Mohammad Ullah Khan is a govt. officer and his regular income remains same & the
total income fluctuates for other income.

Here, in the above tables we can see that, Income = Consumption + savings (Investment). As a result no loan has been taken. Now we will go through the consumption function.

Now we will discuss the four hypotheses mentioned before to analyze our data and try to match our data with each of the hypothesis.

The analysis is furnished below—

The Absolute income hypothesis:

This hypothesis has developed by Jhon Maynard Keynes which says that the individual consumer determines the fraction of current income he will devote to consumption on the absolute level of that income. All things being equal a rise in the absolute income will lead to decrease in the fraction of that income devoted to consumption.

If we analyze our data to compare with absolute income hypothesis we can see the following features-

Here, it is seen that when income increases, consumption also increases. Every additional income is distributed into consumption and savings so if income increases by taka 1 consumption will increase less than taka 1. And when income increases APC goes down.
So, if income increases, APC gradually goes down – this statement is consistent.

Relative Income Hypothesis 🙁 James Duesenberry)

According to Dussenberry’s relative income hypothesis, consumption of an individual not only depends on his absolute income but also of his relative position in the society, that is, his consumption depends on his income relative to the income of other individuals in the society. If the incomes of a community increase by the same percentages then their relative income remain same, though his absolute income would increase. Thus, APC will remain same. Because of socialism or belonging to the status if income increases, consumption will not so much increase compared to the income in the short run. On the other hand, if income decreases, consumption will not decrease so much compared to the income.

For my family, this theory is very much applicable.

This theory indicates that if income of a family increases but the income of the other families in its society does not increase then the family’s consumption will not increase as much as the income and it will consume a smaller fraction of its increased income as it moves to higher income level. Thus both the MPC and APC will decrease with the increase of income in the short run. In my family the MPC and APC is as follows—

So when income income increases its APC and MPC decreases.

The Permanent Income Hypothesis 🙁 Milton Friedman)

This theory states that consumption is determined by long-time expected income rather than current level of income. This long-time income is known as permanent income on the basis of which people make their consumption. According to Friedman people plan their consumption on the basis of expected average income over a long period which is called permanent income. In addition to permanent income, the individual’s income may be transitory income, which is the irregular income. Transitory income may be positive or negative. Such as, income of overtime period, bonus, and compensation etc. Thus income of an individual consists of two parts, permanent income and transitory, which may be stated as:

When cloth is purchased for long run purpose, then it is permanent consumption. But when it is purchased because of an attractive sale price is transitory consumption.

In accordance to this theory:–
Cp = f (Yp)
Ct ≠ f (Yp)
Cp ≠ f (Yt)
Ct ≠ f (Yt)

In our case as a service holder Mohammad Ullah Khan’s permanent income is salary and a least expected amount of rent and his transitory incomes are bonus, arrear bills, income from audits etc. The guest expenses and medicine expenses are transitory expenses as these expenses are uncertain. Here we can see that the consumption does not depend on the permanent income, but it depends on the total amount of actual income. The consumption increases as the real or actual measured income increases, whereas the permanent income – the salary does not increase at all. So, the nature of consumption of my family does not agree with the permanent income hypothesis.

Life-Cycle Hypothesis ( Franko Modigliani):

This theory states that the consumption in any period is not a function of current income of that period but of the whole life-time expected income.
This hypothesis is divided the consumption into three part. Such as:

• Deficit (At earlier age)
• Surplus (Middle age)
• Deficit ( At the end of life)

In early age a man spends by borrowing from others or from his parents. In his main working years, he consumes less than he earns and make positive savings. After retirement, he consumes more than he earns. This hypothesis also thinks that total deficit of a person’s life is equal to total surplus of that person’s life.
The consumption function may be-
C = f (Y, Age)

Here, for this family, in accordance with this theory, Mohammad Ullah Khan is in the surplus position, because he is the only earning person, and all other members in the family are in deficit position of their income level because they are fully dependent for consumption. After his retirement he will be in deficit consumption, and then the consumption of his whole life may match with the life cycle hypothesis.

_____________________

Prepared by—

Laila Arjumand Banu
Roll – 12-031

Consumption analysis of Md. Anwarul Islam and his family

Our family consists of four members. Md. Anwarul Islam is the only earning member of our family and other members are dependent on him. The object of this analysis is to analyze the consumption behavior of our family according to four hypotheses of economics. Each of these four hypotheses involves a quite specific but different view of consumer behavior-that is, each assigns a different view role to income as an influence on consumer spending. The four hypotheses are-

1. Absolute income hypothesis
2. Relative income hypothesis
3. Permanent income hypothesis
4. The life cycle hypothesis

The income, consumption, and savings of our family from 2005 to 2007 are given below:

Income of our family: Md. Anwarul Islam is a service holder and his regular income remains same but the total income fluctuates for other income.

Here, in the above tables we can see that, Income = Consumption + savings (Investment). As a result no loan has been taken. Now we

This hypothesis has developed by John Maynard Keynes. The basic theme of this theory is that consumption depends on only income. This theory indicates that consumption does not depend on other variable. A rise in absolute income will lead to a decrease in the fraction of that income devoted to consumption. That means, if income increases, consumption must be increased but the APC will gradually decrease. Because every additional income is divided into consumption and savings.

If we analyze our data to compare with absolute income hypothesis we can see the following features-

We know that if income increases, APC will decrease. Income in 2007 is greater than 2006. So the APC of 2007 is less than in 2006. But income in 2006 is greater than 2005 but the APC are same.
So if income increases, APC gradually goes down – this statement is not consistent in reality.

Relative Income Hypothesis 🙁 James Duesenberry)

According to Dussenberry’s relative income hypothesis, consumption of an individual not only depends on his absolute income but also of his relative position in the society, that is, his consumption depends on his income relative to the income of other individuals in the society. Relative positions may be socialism, belongingness to the status. Because of socialism or belonging to the status if income increases, consumption will not so much increase compared to the income in the short run. On the other hand, if income decreases, consumption will not decrease so much compared to the decrease in income. If the income of a whole community increases then their relative incomes remain same so the fractions of income consumed remain the same and the consumption curve moves upward.

For my family, this theory is very much applicable.

This theory indicates that if income and consumption will be doubled compared to before and the income of other families in its society also be doubled then, it’s APC does not change.

So when income is doubled its APC remains same.

But if the income of a family in a community becomes high relative to the income of the other families in that society then the APC goes down. When the income of a family rises above the average income of the families of the society to which it belongs, the APC of that family goes down. Here, in our family in the first two years the APC was same because the income was not above the average income of the society to which it belongs. But in 2007 the income rose above the incomes of other families of its society. That’s why the APC has decreased. Thus the consumption of our family fits with the relative income hypothesis.

The Permanent Income Hypothesis 🙁 Milton Friedman)

This theory states that consumption is determined by long-time expected income rather than current level of income. This long-time income is known as permanent income on the basis of which people make their consumption. According to Friedman people plan their consumption on the basis of expected average income over a long period which is called permanent income. In addition to permanent income, the individual’s income may be transitory income, which is the irregular income. Transitory income may be positive or negative. Thus income of an individual consists of two parts, permanent income and transitory, which may be stated as:

Ym=YP+YT

Here,
Ym is referred income in period,
Yp is the permanent income,
Yt is the transitory income.

Salary, regular income in business and income from property may be permanent income. Transitory income is unpredictable income such as bonus, compensation etc. When cloth is purchased for long run purpose, then it is permanent consumption. But when it is purchased because of an attractive sale price is transitory consumption.

In accordance to this theory:–
Cp = f (Yp)
Ct ≠ f (Yp)
Cp ≠ f (Yt)
Ct ≠ f (Yt)

In our case Md. Anwarul Islam, as a service holder has permanent income such as- salary, rent and income from land and has transitory income which are bonus, arrear bills, income from audits etc. In this case the guest expenses and medicine expenses are transitory expenses as these expenses are uncertain.

According to permanent income hypothesis the consumption of a family depends on the permanent income. But in our family, the consumption not only depends on the permanent income but on the total amount of income. So, this hypothesis does not match with our family.

Life-Cycle Hypothesis ( Franko Modigliani):

Life cycle hypothesis thinks that consumption depends on time period (age). Consumption of an individual differs towards his whole life.
This hypothesis is divided the consumption into three parts. Such as:
• Deficit (At earlier age)
• Surplus (Middle age)
• Deficit ( At the end of life)

In early age a man spends by borrowing from others or from his parents. In his main working years, he consumes less than he earns and make positive savings. After retirement, he consumes more than he earns. This hypothesis also thinks that total deficit of a person’s life is equal to total surplus of that person’s life.
The consumption function may be-
C = f (Y, Age)

Here, for this family, in accordance with this theory, Md. Anwarul Islam is in the surplus position, because he is the only earning person, and all other members in the family are in deficit position of their income level because they are fully dependent for consumption. After his retirement he will be in deficit consumption, and then the consumption of his whole life may match with the life cycle hypothesis.

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Prepared by—

Fuad Al Amin
Roll – 12-107

Consumption analysis of Mr. Shamim Ahmed and his family:

Our family consists of four members. Mr. Shamim Ahmed is the main earning person of the family and other members are dependent on him. The object of this analysis is to analyze the family income and expenditure according to four hypotheses of economics to determine the ways of income influencing consumer spending. The four hypotheses are-
1. Absolute income hypothesis
2. Relative income hypothesis
3. Permanent income hypothesis
4. The life cycle hypothesis

Here, in the above tables we can see that, Income = Consumption + savings (Investment). As a result no loan has been taken. Now we will go through the consumption function.
The consumption is,
C = a + mY

Here, C = Yearly consumption
a = Basic consumption which is autonomous
m = Marginal propensity to consume
Y = Disposable income

This hypothesis was made by Lord Myron Keynes which says that the individual consumer determines the fraction of current income he will devote to consumption on the absolute level of that income. All things being equal a rise in the absolute income will lead to decrease in the fraction of that income devoted to consumption.

Here, it is seen that when income increases, consumption is likewise increases. And when income increases APC goes down which also agrees the theory.

Relative Income Hypothesis: (James Dussemberry)

According to Dussemberry’s relative income hypothesis, consumption of an individual is not a function of his absolute income but of his relative position in the income distribution in a society, that is, his consumption depends on his income relative to the income of other individuals in the society. If the income of all individuals in a society increase by the same percentage then their relative income remain same, though his absolute income would increase. Thus, APC will remain same. Because of socialism or belongingness to the status if income increases, consumption will not so much increase compared to the income in the short run. On the other hand if income decreases, consumption will not decrease so much compared to the income.

For my family, this theory is very much applicable which was identified in monthly basis. Expenses vary month to month for different social factor. Different festivals cause consumption increase despite income constant or decrease.

This theory indicates that if the income of a family doubles and the income of other families of its community also double then, its APC does not change.

Life-Cycle Hypothesis: (Franko Modigliani)

This theory states that the consumption in any period is not a function of current income of that period but of the whole life-time expected income. In the yearly years of life, a man spends on consumption either from borrowing from others or spending the assets bequeathed from his parents. In his main working years, he consumes less than he earns and make positive savings. After retirement, he consumes more than he earns. This hypothesis also thinks that total deficit of a person’s life is equal to total surplus of that person’s life.

The consumption function may be-
C = f (Y, Age)

Here, for this family, in accordance with this theory, Mr. Shamim Ahmed is in the surplus position, because he is the only major earning person, and all other members in the family are in deficit position of their income level because they are fully dependent for consumption.

The Permanent Income Hypothesis: (Milton Friedman)

This theory states that consumption is determined by long-term expected income rather than current level of income. This long-term income is known as permanent income on the basis of which people make their consumption. According to Friedman, people plan their consumption on the basis of expected average income over a long period which is called permanent income. In addition to permanent income, the individual’s income may contain transitory income, which is the income that is not going to keep up in future periods. Such as income of overtime period, bonus etc. Thus income of an individual consists of two parts, permanent income and transitory, which may be stated thus:

Ym = Yp + Yt

Here,
Ym is referred income in period,
Yp is the permanent income,
Yt is the transitory income

This hypothesis also divides consumption into permanent and transitory. When clothes are purchased for long run purpose, then it is permanent consumption. But when it is purchased because of an attractive sale price is transitory consumption.

In accordance to this theory, consumption depends only on permanent income. Transitory consumption does not depend on income; only permanent consumption depends on permanent income. That means—

Cp = f (Yp)
Ct ≠ f (Yp)
Cp ≠ f (Yt)
Ct ≠ f (Yt)

This hypothesis does not match with our family’s consumption pattern. Because, the consumption of this family varies with the real amount of income and does not depend on the expected permanent income.

But the hypothesis matches to our family consumption on one point. That point is—the transitory consumption does not depend on the transitory income. As a businessman, Mr. Shamim Ahmed has transitory income from his business operation such as fine or fee for delay receipt of product or materials. So a part of his income from business operation is transitory income as well as the additional income in this case is transitory income. In this case, the guest expenses and medicine expenses are transitory expenses as these expenses are uncertain. But these transitory expenses do not depend on the transitory income. These expenses are just incurred when needed.

After comparing the consumption behavior of the five families analyzed by us- Israt Binte Salim, Kaniz Fatema, Nazia Mahmuda, Laila Arjumand and Fuad Al Amin, we found that not all the families behave in a same way. Different families behave in a different way. No one hypothesis is perfectly applicable to all the families. The consumption of Nazia, Kaniz and Laila’s family matches mostly with the relative income hypothesis and does not match with permanent income hypothesis. While Israt’s family finds the permanent income hypothesis most fitted. And Fuad finds similarity with both the absolute income hypothesis and relative income hypothesis. Even the consumption behavior of a single family does not match with one hypothesis alone. Every family has some similarities with more than one hypothesis. Such as Nazia and Kaniz, whose consumption matches mostly with relative income hypothesis find some similarities with absolute income hypothesis also. Israt’s family does not match perfectly with the permanent income hypothesis, but finds similarity with relative income hypothesis on the fact that the APC, instead of remaining the same, decreases with the increase in income. And all of us found our consumption behavior matched with the life cycle hypothesis also.

Israt’s figures are taken from permanent income and consumption. Because, her actual consumption has no relation with actual income. In 2007, her family faced a large amount of negative transitory income but yet its actual consumption increased.

We can see the families belong to different income level. If we plot the income and consumption of the families of different income level and see whether the consumption has any relation with the level of income, then we can find the following graph—

Here we can see the consumption does not follow any trend. Sometimes it is high and sometimes it is low. Some families consume less than other families whereas their income is higher than the others. Below we will try to justify this scenario on the basis of the four hypotheses and find out why this fluctuation happened—

Absolute income hypothesis:

Absolute income hypothesis says that the fraction of income devoted to consumption depends absolutely on the amount of that income and consumption must increase with the increase of income. According to this, if consumption depends on absolute figure of income and consumption must increase with increase in income, then a higher level of income must have a higher level of consumption. But here, we can see that a higher level of income has a lower level of consumption. The income of Laila’s family is 5,25,000 and of Fuad’s family is 5,08,000, but the consumption of Laila’s family is 4,40,000 whereas consumption of Fuad’s family is 4,97,500. Thus, inspite of having a higher level of income Laila’s family consumes less than Fuad’s family. And the same is true for Kaniz’s family. This situation conflicts with the argument of Absolute Income hypothesis that- consumption depends absolutely on income. There must be some other factors influencing the consumption, for which the scenario is like this.

Relative Income Hypothesis:

This hypothesis says that, the fraction of income a family will devote to consumption depends on the relative income of other families in the community to which it belongs. If a family’s income rises above the income of the other families to which it identifies, then the consumption of that family does not rise much. In other words, the consumption behavior of a family remains closer to the consumption behavior of the other families of its community in the short run, no matter how much higher or lower the income is. A family, whose income is high relative to the average income of other families in its community, consumes a lower fraction of its income than other families whose income is lower or equal to the average income of their community. Here, in our case, the difference in consumption of the families can be justified by this argument of Relative Income hypothesis. Such as—

The income of Fuad’s family is lower relative to the social status to which his family belongs. That’s why, his family consumes a very large fraction of its income and its APC is 0.98. On the other hand, the income of Laila’s family is higher than the income of Fuad’s family, yet her family’s consumption is lower than the consumption of Fuad’s family. Because, the income of her family is not so low relative to the social status to which her family belongs.

Then, if we look at Kaniz’s family, we can see that, the income of this family is even higher than the income of Laila’s family. But, its consumption is much lower than Laila’s consumption, and its APC is also very low (0.69), compared to the APC of Laila (0.84). This happened because, the income of this family is higher than the income relatives of other families to which it identifies.

If we look to Israt’s family, we can see that, here the APC is much lower (0.38) than the other families. Because this family’s income is very high and this income is relatively high in the society to which it belongs. So, the family does not need to consume as much as the income.

So, we can say that, the Relative Income hypothesis is somewhat consistent with the findings of our analysis.

Permanent Income hypothesis:

The permanent income hypothesis does not match with all of our families. Only Israt finds this hypothesis consistent with the consumption behavior of her family. But with other’s family this hypothesis is not consistent. Those families do not consume depending on their permanent income but their consumption in a period depends on the total income of that period. Thus this hypothesis is not consistent to all type of families. It depends on the nature of individual families. Some families make a long term perception or approximation about its permanent income and plan their consumption accordingly. And some families make their consumption of a period on the basis of the total income of that family in that period.

As the consumption behavior of all the family do not match with the permanent income hypothesis, this hypothesis can not be applied to the compared data of the families.

Life-Cycle Hypothesis:

All of us have agreed on one point while analyzing the consumption behavior of our family. The point is that, each person’s consumption behavior in his or her whole life is consistent to the argument of the Life-cycle hypothesis. The hypothesis says that, an individual consumes more than his income in the early years of his life. In the middle age or the middle years of his working life his income exceeds his consumption and he saves for future. Finally in the late years his consumption again exceeds his income. All of us think that, if we could look back to the early ages of our father’s life, we could have seen that his consumption was more than his income. The data we have here is the data of there middle age. That’s why there consumption is less than there incomes and they save the rest for the future. And in the late years of their life or after their retirement, their income will decline and they will consume more than their incomes and make dissavings from their accumulated savings during these middle years. Thus, their consumption behavior agrees with the argument of Life-Cycle hypothesis.

Other reasons for the difference in consumption:

Above we said that, the difference in the fraction of income consumed of our families is caused because of the relative income. But there are many other reasons for which the APC of the families differ.

One reason can be the number of family members. A large family has to consume a larger fraction of its income than another family whose family is small with the same level of income.

Another reason can be the extent to which a family gives importance to future consumption over present consumption. Some families spend more and save less. And some families spend less and save more for making larger expenditure in the future. Here, in our case, we can see Israt’s family’s income is much higher than the income of other families, but the consumption is not so much higher than the others. Because the family saves a larger portion of its income for making expenditure of large amount in the future such as- purchasing house or car etc.

Another reason can be the desire of a family to attain a higher social status in the future.

There are also some other factors for which different families behave in a different way such as—expectation of future price, financial assets, individual preferences etc. the data regarding these factors was not available, so we could not analyze them.

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We have tried our best to make a complete analysis on family consumption behavior. But, unfortunately, we could not make our analysis perfect and complete and we could not justify all of our observations accurately. Based on whatever knowledge we have, we tried our best. From our analysis, what we have observed and what we have found from that observations are discussed below—

Observations:

From the analysis of individual families, we have observed that, the consumption behavior of all the families is not same. Different families behave in a different way. No one hypothesis match with all the families. Different family’s consumption behavior matches with different hypothesis. Some families’ consumption behavior mostly matches with Relative Income Hypothesis, where another family’s consumption behavior mostly matches with Permanent Income Hypothesis. But none of the families’ consumption matches exactly with one hypothesis. They have some similarities with one hypothesis and also some dissimilarities with that. And no family matches to one hypothesis alone. Those family that matches mostly with one hypothesis, have similarities with other hypothesis also. Each family matches with more than one hypothesis.

Those families, whose consumption matches with relative income hypothesis, also match with absolute income hypothesis. Because, these two hypotheses itself have similarity with each other. The difference between these two hypotheses is mainly in the short run. In the long run, their APC are the same. That family, whose consumption matches with permanent income hypothesis, also agrees with relative income hypothesis in some points. And all of the five families’ consumption behavior agrees with life-cycle hypothesis. All of us found that, the fraction of income a person will devote to consumption depends on his or her age bracket.

From analysis of the compared data of all the families, we again found that, no hypothesis exactly matches with it. Though Relative Income Hypothesis matches with it to some extent, it does not exactly fit with the data.

Findings:

After observing the above situation, we found that, a family’s consumption spending does not depend on only one factor, but it depends on various factors at a time. That’s why no one hypothesis alone is fitted to a family. Because, each hypothesis considers only one factor influencing consumption. But the reality is that, each of the factors suggested by the four hypotheses has influence on consumption spending. Each of the arguments of the four is true, but not one argument alone is true. A family’s consumption spending not only depends on its absolute income but also on relative income of the society, expected permanent income and age bracket. All of these factors can influence the amount of consumption spending. A family, which plans its consumption depending on its expectation of permanent income, can also be influenced by the relative income of the other families to which it identifies. Thus a family’s consumption spending can be influenced by several factors simultaneously.

Other factors influencing consumption:

While making the study on the family income and consumption, we also found that, an individual’s or a family’s consumption spending not only depends on income, belongingness to society, expected permanent income or age bracket. It also depends on other factors besides these four factors. Those factors have not been considered by the four hypotheses. We could not found specific data regarding these factors. That’s why we could not show the influence of these factors on consumption spending of our family. But we found that, these factors influence the consumption spending of an individual. Some of the factors are discussed below—

One factor can be sex. The fraction of income a person will devote to consumption depends on whether the person is male or female.
Another factor is interest rate. Normally consumption is not affected by interest rate. But if the interest rate is too much high then consumption decreases.
Another factor is inflation. If there is inflation, there may be a perception in people that, the economic condition is not good and consumption should be decreased. The opposite may happen also. Because it is an illusion, it can not be defined. It depends on whether peoples think inflation as a good news or a bad news.
Another factor is expectation regarding future prices. If people expect that price will rise in future, then people will increase their expenditure and demand in present. Thus the expenditure will rise because of the expectation of price, not because of the income or the price.

Thus an individual’s or a family’s consumption spending depends not only on income but on several other factors and not all individual or all families behave in the same way.

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