The Implications of Friedman's Permanent Income Hypothesis for Demand Analysis

The measurement of income elasticities of demand for farm products, both individually and as an aggregate, is a fundamental problem which has concerned a considerable number of agricultural economists. Professor Milton Friedman's recent study, A Theory of the Consumption Function (3),1 investigates the relation between aggregate consumption and aggregate income. Though addressed to the general economist, it is of special interest to economists and statisticians engaged in the study of factors affecting the consumption and prices of farm products. Friedman presents a fundamentally new view of the consumption function, which he terms "the permanent income hypothesis." Central to this hypothesis is a sharp distinction between measured income, or that which is recorded for a particular short period of time, and permanent income, a longer term concept. His analysis, if correct, suggests that current methods for measuring income elasticities of demand are generally inadequate. This paper contains a summary of Friedman's position; an appraisal of its implications for the analysis of demand for individual commodities; the formulation of an alternative to the permanent income hypothesis; and a test of their relative merits. It is hoped that this presentation will make the permanent income hypothesis more widely known and will stimulate further investigations in this area by agricultural economists.