Life Cycle Hypothesis
The concept of life cycle hypothesis is just opposite to what Keynesian function of consumption says. The Keynesian consumption theory is primarily based on the current income of the individuals while the concept of LCH says that the consumption of the individuals is based on the constant percentage of the life income's present value.
According to the life cycle hypothesis, the individual consumption is governed by the tastes, preferences and income of the individual. Modigliani and Ando further argue that the average propensity to consume is larger in the old households and among young people.
This is because the old people run their lives on their life savings while the young people are more into borrowing. The middle-aged people, on the other hand, incline to have higher incomes with lower consumption and higher saving.
While examining the natural tendency of people to spend, we need to first understand the economic goals that they have. There may be two goals - people spend because they prefer to live a life with better standard of living and that most people also try to maintain more or less constant living standard through out the life time. This is the human nature that explains the logic behind the life cycle hypothesis. This hypothesis tries to justify the reason behind the tendency of the individuals when their spending is not only governed by the income but also regulated by taste and standard of living. The life-cycle hypothesis takes a microeconomic view to the consumption function.
The life cycle hypothesis fails to explain the situation when the income of an individual fluctuates unpredictably. But the life cycle hypothesis can be expanded to explain various situations like - the uncertain situation when death happens, numerous approaches of lifetime earnings, existence of social security and also the interest rate.
More Information On Savings
Last Updated on : 3rd August 2013