The Absolute Income Hypothesis is theory of consumption proposed by English economist John Maynard Keynes

John Maynard Keynes

John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...

 (1883–1946), and has been refined extensively during the 1960s and 1970s, notably by American economist James Tobin

James Tobin

James Tobin was an American economist who, in his lifetime, served on the Council of Economic Advisors and the Board of Governors of the Federal Reserve System, and taught at Harvard and Yale Universities. He developed the ideas of Keynesian economics, and advocated government intervention to...

 (1918–2002).

Background

The theory examines the relationship between income

Income

Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...

 and consumption

Consumption (economics)

Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...

, and asserts that the consumption

Consumption (economics)

Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...

 level of a household

Household

The household is "the basic residential unit in which economic production, consumption, inheritance, child rearing, and shelter are organized and carried out"; [the household] "may or may not be synonymous with family"....

 depends on its absolute level (current level) of income

Income

Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...

. As income rises, the theory asserts, consumption will also rise but not necessarily at the same rate.

Marginal propensity to consume

Marginal propensity to consume

In economics, the marginal propensity to consume is an empirical metric that quantifies induced consumption, the concept that the increase in personal consumer spending occurs with an increase in disposable income...

 is present in Keynes' consumption theory and determines by what amount consumption will change in response to a change in income.

While this theory has success modeling consumption in the short term, attempts to apply this model over a longer time frame have proven less successful. This has led to the absolute income hypothesis falling out of favor as the consumption model of choice for economists.

Model

Where:

• is consumption at time t.
• is the Marginal propensity to consume
  Marginal propensity to consume
  In economics, the marginal propensity to consume is an empirical metric that quantifies induced consumption, the concept that the increase in personal consumer spending occurs with an increase in disposable income...
  
  ()
• is income at time t.