Relative Income Hypothesis (English) - YouTube

hello and welcome to the E.Z classes in this video we will discuss the relative

income hypothesis of dusenbery relative income hypothesis is one of those

post-keynesian hypothesis they were propounded after a discrepancy was found

when the Keynesian consumption hypothesis was tested for the long term

and for the short-term data the long-term data of the I mean the time

series data when used to test the consumption hypothesis of Keynes give

the consumption function of proportionality that is consumption

function has to be one that will come from the origin where here you are

measuring the income here consumption so it will be of non

proportionality that is C =bY okay so where B is marginal

propensity to consume as well as average propensity to consume and both are the

same because it is coming from the origin but when the consumption function

was obtained from the cross-sectional family budget data

this type of consumption function was formed that has this intercept where

sorry let me give it a so this is a so C= b Y when a is

constrained that is intercept and b is same as the marginal propensity to

consume but in this case marginal propensity to consume is different from

average propensity to consume and MPC is less than A PC and APC is declining

it's not constant okay because up to the income level suppose y1

APC has to be greater than 1 in this case and at this level of income APC is

equal to 1 and after that here APC is less than 1

while marginal propensity to consume in this case is constant okay and it will

be constrained unless the consumption function is the curvilinear one but no

matter that Keynes own belief that consumption function would be that of

non proportionality and a curvilinear that does not diminish the Keynesian

significance because Keynesian significance lies elsewhere that we have

already discussed when we took up Keynesian consumption function for

discussion but post-keynesian hypothesis were propounded it in order to resolve as

to why at all two types of data are producing the two different types of

consumption function one is a proportional one that is based on the

long term time series data in the another one which is based on the

cross-sectional family budget data then gave the consumption function of non

proportionality so several hypotheses one such hypothesis we have already

discussed in this E.Z classes that was the life cycle hypothesis of Modigliani

today I am going to discuss the relative income hypothesis of Duesenberry

propounded the hypothesis that you can find on the board here that is a

relative income hypothesis now Keynesian hypothesis most sample Keynesian

hypothesis was the current consumption is a function of current

absolute level of current income other

things assumed to remain constant the Duesenberry propounded the hypothesis that

consumption function consumption expenditure of the individuals does not

get affected by only the income but there are other factors as well and it

is the distribution of income or once income in relation to other one that

also impacts the consumption expenditure for example there are two persons with

different levels of income and there is a certain amount of difference between

the two so when their income Rises the consumption function a consumption

expenditure of the individual will in rise in proportion to that so as to

maintain that proportion so I will explain that simply speaking this

distribution of income effects in such a way for example there are three

individuals A, B and C okay suppose a has the monthly income of suppose $3000 in B

has $4000 and C has $5000 you can take it in the for whatever could be the daily

income so A happens to be the poorest one in relation to other no suppose

these three are in of one locality or these three are situated or I mean they

are living in such a way that they interact with each other so they know

each other they influence each other they are in a contact on the other hand

there could be another distribution of income suppose X Y Z where X is having

income of $1000 y $2,000 and Z is $3,000 okay now here although

person Z is having the $3,000 income which in relation to others with whom he

is intersecting and with whom he has the social relation he happens to be at the

highest level of income distribution while with the same amount of income in

another distribution A happened to be the poorest one obviously in relative

term so this will affect their consumption expenditure A will be very

much influenced by the consumption expenditure of B and B will be very

influenced by the consumption expenditure of C so when B's

consumption expenditure will rise A will try to imitate that so as to maintain

the same ratio or same proportion of the consumption expenditure as it was prior

to the increase in income so that is the logic okay so let us try to explain the

consumption function or the relative income hypothesis with the help of graph

there are two types of effect one is the demonstration effect

the one such effect is the demonstration effect that whatever one is observing of

one gets influenced by that and second is ratchet effect ratchet you might know

that is a mechanical device otherwise that supports the movement only in one

direction the best example could be that of a

bicycle where when you pedal forward your bicycle will move through a device but

when you pedal in the backward direction this ratchet or that device will not

move the or will not make the wheel moving in the backward direction okay so

it can move so that is ready defect so first let me explain the influence of

the demonstration effect and see as to how the puzzle of proportionality and

non proportionality of consumption function can be can be explained now let

me draw a diagram to explain the demonstration effect we can have this

kind of diagram we are on x-axis we measure income and on y-axis we major

consumption okay suppose we draw a consumption function which is in

non-proportional okay non-proportional consumption function which is equal to

C=b +aY where B is intercept this is B

now there are various individuals who have the different levels of income and

as I have explained to you that income distribution it does not matter

especially when amongst those who I mean who live

together in a sense that they are in contact they get influenced by others in

various matters so so is the consumption expenditure also suppose a fellow whose

income level is this in consumption level if this there are number of fellow

so can the income level would be this now if the this fellow Y1 ,Y2

here it was C1 C2 was the consumption level of

an individual - income level of Y2 there was another fellow whose

income level was y1 and his consumption expenditure was C2 know if that

fellow's income increases from a level Y2 to his consumption expenditure

will increase okay like this now this fellow now his income level has

increased to the level when that was the income level of another individual I

mean individual who was having the higher income and he was having this

consumption expenditure so that individual suppose this is A and this is

B this is consumption will not increase by the amount to reach the level of

C2 but it will be more so as to have this relationship and similarly Y 2

will be influenced by the person I mean not by to another person whose income

level is Y 2 when his consumption level is this okay so everybody is trying to

maintain a position in the relative consumption or the relative distribution

of incomes of maintains the same status as far as the consumption is concerned

because they are very much influenced by the consumption expenditure of the other

so when you join these points

you will get the consumption function which is C =aY sorry aY

end but make one thing this is less than 45 degree line this consumption function

let me draw a very straight line that I failed to draw this is because I'm so

this is the proportional consumption function that would be obtained in the

when you observe the data for the long term this is on the long term basis so

that is one effect that the people do have as far as their consumption

expenditure is concerned when their income level rises their consumption

expenditure Rises in the same proportion as their income level rises so that is

one explain of the short-term consumption function is this a long-term

consumption function will be obtained will be off of that proportionality now

there is another angle of viewing the figure from the proportionality of the

consumption function here we have observed the function from the non

proportionality to proportionality okay now suppose we have now we are

explaining the ratchet effect suppose this is a consumption function

C = aY

okay this is proportional consumption function now December II was

of the opinion that this is a pattern that a fixed portion of income gets

consumed when income of the people arises okay but the same pattern will

not be followed if the individuals in income decline there could be

possibility the some of the individuals would be would have found that their

income as in decline okay now Duesenberry was of the opinion

he hypothesizes hypothesis anyway is the statement which is subject

to the empirical test so Duesenberry hypothesized that when people's income

declines his consumption expenditure does not follow the same path for

example this is the path when income is rising consumption but when comes income

declines this path will not be followed rather if income has declined from here

it will be like this or let me draw it by the dotted line okay I mean this will

not be following this path rather than this path right why does this happen

this happens because in his views and probably he's reasonably sounds

reasonable then it becomes difficult for individual to come down from the level

of consumption that he had already attained from that it becomes difficult

so when tries to maintain the same level of income that he was once having this

he does by drawing down the past saving he might be doing it by borrowing or

might be some other reason but he would may be curtailing the saving curtailing

the current saving okay earlier he might be consuming some

portion of the consumption now his for consuming the greater portion of that income

so that prevents him from the coming down to the same level when that

in consumption level previously was he so this concern is that happiness for

all and that that happens to every individual that one once income declines

this does not suppose individuals here if its income Falls is consumption

pattern will be this so this kind of consumption function could be obtained

for the short-run and that results that isn't from the

reverse of the income when income level declines in it is the Ratchet effect

that it refuses to move the things in the backward direction as happens in case

of a bicycle so this consumption function is that of non

proportionality where here you are measuring income consumption so this

is long-term consumption in short-term consumption could be obtained from so we

have seen or what does Duesenberry had presented that from the short-run it

could be obtained then you can find that because of the demonstration effect

long-term consumption function could be that of proportionality or from the

long-term consumption function you can have many short-run consumption function

that could be the non-proportional one so this is one such attempt to resolve

the puzzle created by the discrepancy in the short run and the long run

consumption function after Keynesian hypothesis was tested empirically so

guys thank you very much