The famous economist Milton Friedman

Question

The famous economist Milton Friedman proposed the theory that individuals base their consumption (buying goods and services) on their expected long-term disposable income, their "permanent disposable income", rather than on their current disposable income. A particular college student has consumption function of

C(I) = 0.8I+0.8(sqrt(I+100))

thousand dollars with annual disposable income I thousand dollars, and has expected annual disposable income of

D(t) = (10+80t)/(t+1)

thousand dollars t years from now.

A) If the college students consumption were based on current disposable income, rather than permanent disposable income, approximately how much would they consume?

B) What is the permanent disposable income, I*, for this individual?

C) Use function notation to write the quantity consumed based on the permanent disposable income I*. If true, how much more will the college student consume this year based on Milton Friedman's permanent income theory compared to spending based on current disposable income?

Answer 1

D(t) = (10+80t)/(t+1)

For current disposable income, t= 0.

D(0) = (10 +80*0)/(0+1) = 10/1 = 10

C(I) = 0.8I+0.8(sqrt(I+100))

C(10) = 0.8*10 + 0.8*√(10 + 100)

≈ $16,390

What is Friedman's definition of permanent disposable income? t=?