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Unit-8: Relative Income Hypothesis

that consumption relation is not permanent. The establishment of that hypothesis is that consumption Notes
will increases during the period of prosperity and slowly-slowly it will adjust on more high status.
Once when people are reaching on special high status and habitual of that life-status then they did
not want to leave his consumption structure during depression. In the words of Dussenberry, “In
starting for any family in spite of stop more expenses, reduce expenses from high status is tougher.
So incomes reduces then consumption also reduces but in low proportion in spite of increment in
income, because consumer expenses for consumption. Other side, when income increases during
the period of recovery, then consumption increases with the fast increment in saving". It says the
economist Ratchet effect.

Notes The consumption behaviour of every person is not free but it depends on the
behaviour of every other person.

Dussenberry presents as following to mix his both rivalry hypothesis-

C t =− Y t
ac
Y t Y 0

Self Assessment

Fill in the blanks:
1. Relative income hypothesis of James Dussenberry is based on the rejection of basic assumption
of consumption principle of………………
2. The consumption behaviour of every person is not………………..
3. Consumption relation is…………………..in time.
Where C and Y is serially consumption and income, t is current
period, (o) is last maximum status and a is a constant related
with positive autonomous consumption and c is consumption
function. In that equation, consumption-income ratio (C /Y )
t
t
(= APC) is consider the function of Y /Y in current period
0
t
means the ratio of current income from last maximum income.
If that ratio is constant, as happen in increasing income period
by stability, then current consumption income ratio is constant.
During depression, when current income (Y ) fells down from last
t
maximum income status (Y ), then current consumption income
0
ratio (C /Y ) will increases. Fig. 8.1
t
t
Relative income hypothesis is explained in figure 7.5 from graphics form where C is long period
L
consumption function and C and C is short period consumption function. Assume that income is on
S2
S1
maximum status of OY where consumption is E Y . Now income fells and become oy . Because people
1
1
1
0
are habitual of life-status on oy level, so they did not reduce their consumption on E Y status, but they
0
1
0
reduce their current saving and will reduce their consumption as possible. So, they will reach on C
1
point going backwards on Cs curve and will on C Y status of consumption. When recovery duration
0
1
1
starts, then income increases and reaches on maximum level OY . But consumption reached on C and
1
1
E slowly- slowly with Cs curve because consumer will again establish last status of his savings. If
1
1
income increases and reached on OY status, then consumer will reach on short period consumption
2
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