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The Life Cycle Hypothesis (LCH), introduced by Franco Modigliani and his collaborators, is a fundamental framework in macroeconomics that explains household consumption and saving behavior over the life span of an individual. The central premise of the hypothesis is that individuals plan their consumption and savings in a way that maximizes lifetime utility, taking into account their expected income at different stages of life. This approach offers a dynamic view of consumption and saving patterns, diverging from simpler models that assume consumption depends solely on current income. A salient feature of the life cycle hypothesis is its emphasis on the intertemporal allocation of resources. According to LCH, individuals aim to smooth consumption over their lifetime rather than allowing consumption to fluctuate directly with current income. This implies that when people are young and their income is low, they may borrow or rely on family support to maintain a desired level of consumption. During their working years, they save a significant portion of their income to finance retirement. In the retirement phase, when labor income declines or ceases, individuals dissave by using the accumulated savings to maintain consumption levels. This intertemporal approach provides a more realistic depiction of consumption behavior compared to the Keynesian consumption function, which posits that consumption is primarily determined by current income. Another key feature of the LCH is its consideration of predictable life events and income patterns. The model assumes that individuals have foresight regarding their future earnings and plan accordingly. This planning horizon encompasses not only the working life but also retirement, and potentially the financial support needed for children or dependents. The hypothesis also introduces the notion of ‘permanent income,’ __________ ___ _______ _________ ___.
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