This paper examines consumer response to windfall income. By using data from the 1972-73 Consumer Expenditure Surveys, an attempt was made to test Friedman's permanent income hypothesis. The results revealed that the marginal propensity to consume regular income was greater than the marginal propensity to consume windfall income for windfalls that were large relative to regular income. However, when windfall income was less than ten percent of regular income, the relationship reversed. Implications are drawn for short and loegrun fiscal policies affecting consumersThe permanent income hypothesis has served several purposes in consumption theory and policy. It has contributed to the reconciliation of short-run and long-run estimates of the consumption function and identified lags in the reactions of consumers to changes in income. Knowledge of the lags permits a better understanding of the timing of government policy effects. In addition, it has introduced a framework for explaining consumer reactions to transitory and permanent income changes. The 1968 tax surcharge episode and other temporary government actions1 such as current reversals in tax policies have established the importance of the policy implications.The hypothesis is open to empirical testing as well as requiring estimation of the parameter values. Many tests have been performed 'Several articles have discussed the 1968 tax surcharge in terms of the permanent income hypothesis; see, for example, [17].
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