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The permanent-income theory of consumption

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Question: The permanent-income theory of consumption: According to the permanenting come hypothesis, how does your consumption change in each of the following scenarios? (The first question is answered for you.) To keep things simple, suppose the interest rate is 10% and you will live forever. Feel free to give answers that involve approximations.

(a) A distant aunt that you never knew dies and leaves you $100,000 in her will. (Answer: Consumption rises today and in the future by a constant amount, equal to the "permanent-income equivalent" of the $100,000. Since you live forever, you can raise your consumption by the amount of interest earned on the bequest. So consumption rises in every period by 0.10 × $100,000 = $10,000.17)

(b) You receive an unexpected promotion today that raises your income permanently by $5,000 per year.

(c) To balance its budget, the government levies a onetime tax this year that costs you $10,000.

(d) You win a lottery, which pays you a onetime amount of $10 million today.

(e) You win a different lottery, which pays you a onetime amount of $10 million, but the payment is made 5 years from now.

Reference no: EM131634498

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