Macroeconomics

F I G U R E  

1 7 - 2

Consumption, C

Income, Y

Short-run

consumption function

(falling APC)

Long-run

consumption function

(constant APC)

The Consumption Puzzle

Studies of household data

and short time-series found

a relationship between con-

sumption and income simi-

lar to the one Keynes conjec-

tured. In the figure, this rela-

tionship is called the

short-run consumption func-

tion. But studies of long

time-series found that the

average propensity to con-

sume did not vary systemati-

cally with income. This rela-

tionship is called the

long-run consumption func-

tion. Notice that the

short-run consumption func-

tion has a falling average

propensity to consume,

whereas the long-run con-

sumption function has a

constant average propensity

to consume.

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how Modigliani and Friedman tried to solve the consumption puzzle, we must

discuss Irving Fisher’s contribution to consumption theory. Both Modigliani’s

life-cycle hypothesis and Friedman’s permanent-income hypothesis rely on the

theory of consumer behavior proposed much earlier by Irving Fisher.