Authors: Shad Ali Khan, Dr. Shikhar Kumar
Abstract: This research paper examines the concept of consumption Puzzle in the long-term context. An eye caching and an important problem in macroeconomics theory which economists have tried to solve for decades. The mirage of a given predicted relationship between income and consumption is yet to be supported by theories over the long term. The absolute theory of consumption is an important traditional theory. The theory says changing income will lead to change in consumption but only at a diminishing rate. This concept leads to formation of another important concept that is average propensity to consume (APC) will gradually decrease when the economy grows. According to this reasoning the long run economic growth will be achieved by raising the savings in the economy. Historical economic data shows a distinct trend when examining national income in the long term. As economics grew over many years, both income and spending increased together in almost the same. In simple words, when people earn more over the long term they also spend more and divide their income for future expenditures that make their consumption and income stable in the long run. But according to old theories if the income rises then people should save more of their income and the spending share will change. To solve the consumption puzzle many economists said people do not make spendings by only present income. In fact they think more broadly when their income is increased. The Permanent income hypothesis says that people spend their income on the basis of not only current income but also care about future income. Example: if someone's income increases for a short time or a one-time increment then they may save most of it because they know it is a temporary income change. But when the income changes permanently then they increase their consumption. The Life Cycle Hypothesis also provides a similar idea. It says people plan their spending over their whole life, they may save during the working year, make consumption and save for retirement and sustain their consumption even after retirement. However their low income doesn’t affect their consumption. People not only save for retirement but also have saving habits from generation for emergence funds, education and major household works.
