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The relative income hypothesis

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  • Alvarez-Cuadrado, Francisco
  • Van Long, Ngo

Abstract

Despite its theoretical dominance, the empirical case in favor of the permanent income hypothesis is weak. Contrary to one of its basic implications, a growing body of evidence suggests that rich households save a higher proportion of their permanent income than poor households. We propose an overlapping-generations economy where households care about relative consumption. As a result, an individual's consumption is driven by the comparison of his lifetime income and the lifetime income of his reference group; a permanent income version of Duesenberry's (1949) relative income hypothesis. Across households the savings rate increases with income while aggregate savings are independent of the income distribution.

Suggested Citation

  • Alvarez-Cuadrado, Francisco & Van Long, Ngo, 2011. "The relative income hypothesis," Journal of Economic Dynamics and Control, Elsevier, vol. 35(9), pages 1489-1501, September.
  • Handle: RePEc:eee:dyncon:v:35:y:2011:i:9:p:1489-1501
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    More about this item

    Keywords

    Interpersonal comparisons Relative income hypothesis Permanent income hypothesis;

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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