3.9: Wealth and Expectations of Future Income in Consumption Decisions

Current disposable income is an important factor on which decisions about how much to consume in a given period depend. However, other factors, such as expectations about future income and the current level of wealth, also play a major role. These factors are at the heart of key economic theories, such as the Permanent Income Hypothesis.

If people expect their income to grow, they may feel comfortable spending more today. Richard, for example, expects strong long-term demand for his skills as a software developer. He believes that the boom in AI will create more high-paying jobs in technology. He believes his income will keep rising. He feels confident and spends comfortably on food, travel, and other expenses.

On the other hand, Sarah, who earns the same as Richard, expects little income growth. She believes that automation threatens the jobs of Market Analysts. She lives modestly, spends carefully on food, limits travel, and keeps other expenses low.

Wealth can also affect how much a person spends. Financial assets, such as savings, stocks, or inherited funds, provide security. Richard’s substantial wealth makes him feel financially secure. He comfortably dines out and goes on vacations. In contrast, Sarah’s minimal wealth makes her cautious with money. She dines out occasionally and rarely travels.

These differences show how expectations of future income and current levels of wealth can influence consumption decisions.

Decisions about how much to consume in a given period depend not only on the current disposable income but also on other factors, such as expectations of future income and current levels of wealth.

Richard is a software developer. He expects strong long-term demand for his skills and believes his income will continue to rise. He lives comfortably and confidently, spending on food, travel, and other expenses.

His colleague Sarah, who earns the same income as Richard, has a different outlook. She expects little income growth and lives modestly. She spends carefully on food, limits travel, and keeps other expenses low.

In addition, Richard has substantial financial assets, including stocks and inherited funds. Sarah, on the other hand, has very little wealth.

Richard feels financially secure. He knows he can draw from his wealth during an emergency.

Sarah spends cautiously, dines out occasionally, and rarely takes vacations.

These factors are at the heart of key economic theories, such as the Permanent Income Hypothesis, which considers the influence of expectations of future income and the current levels of wealth on consumption decisions.