macroeconomics

1. z
By : Amrina abid
Relative
income
hypothesis

2. z
Inroduction
Since when doubts raised on absolute income theory economists
start to find the new relationship between income and consumption.
So, in 1949 Dusenberry presented relative income hypothesis.
According to this theory, consumption depends on the relative
position of the individuals in income scale rather than on the current
income.

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Main points
 Dusenberry gave following points to setup the theory:
 Consumption of a person depends upon the locality where he
lives. If he lives in a locality where other person’s are not rich his
consumption will not be very much high.
 If a person lives a high standard locality then he will have to
maintain his life standard and his consumption will high.
 Infect, the value of APC changes when living standard on the
relative position of the people changes.

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Short run consumption function
 It shows non proportional relationship between income and
consumption and APC is greater than MPC.
Family A Family B Family C
Y C APC Y C APC Y C APC
2000 2400 1.2 4000 4000 1 6000 5400 0.8
4000 4800 1.2 8000 8000 1 12000 10800 0.8

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Graphical representation
0
2000
4000
6000
8000
10000
12000
14000
Category 1 Category 2 Category 3 Category 4 category 5 category6
income consumption APC

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Long run consumption function
 Long run shows proportional relationship between income and
consumption APC remains constant and equal to MPC.
C=CY
MPC=APC

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GRAPHICAL REPRESENTATION
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Category 1 Category 2
consumption
income
Chart Title
Series 1 Series 2

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Dusenberry’s view
 According to Dusenberry, it is much easier for a household to adjust
the rising income than the falling.
 as the household’s income rises, his standard of living also rises.
 More specifically, consumption depends upon only on current
income but also depends upon the highest level of income
previously earned or previously peaked income.
 C=f(Yc,PpY)
 Yc= current income
 PpY= previous peak income

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Criticism by RIT
 Increase in aggregate level of income always produces a
proportional increase in consumption.
 Consumption behavior is irreversible. It also shows fall in
disposable income continuous for a long time the consumer will
have to depend upon dissaving.