A Theory of the Consumption Function

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July 16, 2026

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Milton Friedman's "A Theory of the Consumption Function" introduced the permanent income hypothesis. This economic theory posits that consumers base their spending decisions not on their current income, but on their expected long-term income, or "permanent income".123

Key aspects include:
* Consumption Smoothing: Individuals aim to maintain a stable level of consumption over their lifetimes, rather than drastically altering spending based on short-term income fluctuations.2
* Marginal Propensity to Consume (MPC): Friedman argued that the MPC is higher for households with low permanent income and lower for those with high permanent income. This means poorer households are more likely to spend extra income, while wealthier households are more likely to save it.23
* Temporary vs. Permanent Income: Windfalls or temporary income changes have a smaller impact on spending than changes perceived as permanent.12

This theory helps explain economic behavior and the effectiveness of fiscal policies.23

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consumption
The rational optimization framework
economist Milton Friedman’s treatise A Theory of the Consumption Function (1957). The permanent income hypothesis omits the detailed treatment of demographics and retirement encompassed in the life-cycle model, focusing instead on the aspects that matter most for macroeconomic analysis, such as predictions about the nature of the consumption function,…
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economist Milton Friedman’s treatise A Theory of the Consumption Function (1957). The permanent income hypothesis omits the detailed treatment of demographics and retirement encompassed in the life-cycle model, focusing instead on the aspects that matter most for macroeconomic analysis, such as predictions about the nature of the consumption function,…
Read More

Milton Friedman
Academic career and key collaborations
…of his earliest, described in A Theory of the Consumption Function (1957), was the articulation of the permanent income hypothesis, the idea that a household’s consumption and savings decisions are more affected by changes in its permanent income than by income changes that household members perceive as temporary or transitory.…
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…of his earliest, described in A Theory of the Consumption Function (1957), was the articulation of the permanent income hypothesis, the idea that a household’s consumption and savings decisions are more affected by changes in its permanent income than by income changes that household members perceive as temporary or transitory.…
Read More