After Keynes, another economist Franco Modigliani developed a different approach to explain the relationship between consumption and disposable income for prudent consumers. It is called life cycle hypothesis.

A household’s level of consumption depends not just on current income but also, and more importantly, on long-term expected earnings. Individuals are assumed to plan a pattern of consumption expenditure based on expected earnings over their lifetime.

A prudential household plans his consumption expenditure which may provide for occasional rainy days and take care of extra future needs such as schooling of children, contraction of house, meeting day-to-day expenses after retirement. Individuals very often get incremental income, windfall agins, income incentives, etc. They save part of this additional income to provide for known and unknown future consumption expenditure.

In brief, the current spending of a prudent household is closely related to his expected average lifetime income.

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