Definition of Absolute Income Hypothesis
The theory that a person’s consumption and savings decisions are driven solely by their absolute level of income.
Explanation of Absolute Income Hypothesis
The Absolute Income Hypothesis is an economic theory proposed by John Maynard Keynes, suggesting that an individual’s consumption is primarily determined by their current income level. According to this hypothesis, as people’s income increases, their consumption also increases, but not necessarily at the same rate. This theory implies a direct relationship between income and consumption, where higher income leads to higher spending, though the proportion of income spent may decrease as income rises. The Absolute Income Hypothesis contrasts with the Relative Income Hypothesis, which posits that consumption is influenced by an individual’s income relative to others. Keynes’ theory is foundational in understanding consumer behavior and has implications for fiscal policy and economic planning. It suggests that policies aimed at increasing disposable income, such as tax cuts or direct financial aid, can stimulate economic activity by boosting consumption. Understanding this hypothesis helps economists and policymakers design strategies to manage economic growth, stabilize markets, and address income inequality.