Questions: Question 5 (Mandatory) (10 points) According to the Permanent Income Hypothesis, a temporary increase in income that does not affect average lifetime income (lifetime earnings divided by number of years) would - Cause no change in consumption. - Cause a large increase in consumption. - Cause an increase in consumption and saving by the same amount. - Cause a decrease in consumption and saving by the same amount.

The answer is the first one: Cause no change in consumption.

Explanation: The Permanent Income Hypothesis (PIH), proposed by Milton Friedman, suggests that individuals base their consumption decisions on their expected lifetime income rather than their current income. According to this hypothesis, people smooth their consumption over time, meaning they do not significantly alter their consumption patterns in response to temporary changes in income.

• Cause no change in consumption: This is correct because, under the PIH, a temporary increase in income does not affect the individual's perception of their average lifetime income. Therefore, they would not change their consumption significantly.

• Cause a large increase in consumption: This is incorrect because a temporary increase in income would not lead to a large change in consumption if individuals are basing their consumption on their permanent income.

• Cause an increase in consumption and saving by the same amount: This is incorrect because, while saving might increase temporarily, consumption would not increase by the same amount as the temporary income increase.

• Cause a decrease in consumption and saving by the same amount: This is incorrect because a temporary increase in income would not lead to a decrease in consumption or saving.

In summary, according to the Permanent Income Hypothesis, a temporary increase in income that does not affect average lifetime income would cause no change in consumption.