Modigliani’s Life-cycle Hypothesis and life-cycle humps

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Question 1

  1. i) Estimate weekly household income (y)

Household income

=-121.4+(75.56*25)-(0.85*25^2) = $1236.35

=-121.4+(75.56*30)-(0.85*30^2) = $1380.40

=-121.4+(75.56*35)-(0.85*35^2) = $1481.95

=-121.4+(75.56*40)-(0.85*40^2) = $1541.00

=-121.4+(75.56*45)-(0.85*45^2) = $1557.55

=-121.4+(75.56*50)-(0.85*50^2) = $1531.60

=-121.4+(75.56*55)-(0.85*55^2) = $1463.15

=-121.4+(75.56*60)-(0.85*60^2) = $1352.20

=-121.4+(75.56*65)-(0.85*65^2) = $1198.75

=-121.4+(75.56*70)-(0.85*70^2) = $1002.80


  1. Estimate weekly household expenditure (y)

Household expenditure

=-114.35+(71.08*25)-(0.85*25^2)= $1131.40

=-114.35+(71.08*30)-(0.85*30^2)= $1253.05

=-114.35+(71.08*35)-(0.85*35^2)= $1332.20

=-114.35+(71.08*40)-(0.85*40^2) = $1597.55

=-114.35+(71.08*45)-(0.85*45^2) = $1368.85

=-114.35+(71.08*50)-(0.85*50^2)= $1314.65

=-114.35+(71.08*55)-(0.85*55^2)= $1223.8

=-114.35+(71.08*60)-(0.85*60^2)= $1090.45

=-114.35+(71.08*65)-(0.85*65^2)= $914.6

=-114.35+(71.08*70)-(0.85*70^2)= $696.25


Modigliani’s Life-cycle Hypothesis and life-cycle humps

As a theory based on economic principles, the Modigliani Life-cycle Hypothesis explains the behavioural structure that arises from consumers’ need to optimize their spending during their active lives. The model displays the manner in which during the various stages of their lives, individuals will have different incomes, which will be spent in various ways as dictated by their needs. Through analysis of many factors like income, consumption, savings and other life-time activities, over a period when they accumulate wealth as they age, this model helps to develop a pattern that fosters the hypothesis itself. The general idea is based on three assumptions that over a lifetime, peoples consumption for a life-time maximizes as they age, then they continue and peaks as they are about to retire. When they retire, they continue saving, but it stops on their demise.

Humps shown in life-cycle expenditure and income display how age and stages in life-cycle display connection between expenditure and household income. Households change in number or composition of members, hence influence the life-cycle humps for income and expenditure. For instance, on getting newborns, families tend to incur more expenses while the income remains the same. This is because the children do not bring in anything in terms of income. The expenditure will rise since more money will be spent on fees, clothing and food for the children. Further, when these children grow and leave home, the expenditure goes down again since, most probably, the children can now earn their own money and spend it on themselves while the parents stop spending on them, or spend less on them. Other significant humps display the relationship of increasing incomes between 50 and 60 years of age, when people retire .

The Modigliani’s Life-cycle Hypothesis receives a very strong validation through the Australian weekly income and expenditure per household head in 2003 – 2004 since it strongly suggests the thought that consumers are lifetime maximises as they display a higher income than expenditure. As from the age of 25, incomes appear to rise until the point when they peak at 45 ($1557.55), with expenditure peaking similarly at 45($1368.85). Incomes start to show a steady decline at the age of 50, which is around the age when people retire. This happens until the age of 70, when they stop. The main component of the theory bases its ideals on savings, which means that comparisons made between the diagram of expenditure and diagram of income cannot be totally compared with the Modigliani’s life-cycle Hypothesis. Since most families spend more on children between 35 and 50 years of age, it is only natural that this be seen as the age around which expenditure levels rise since more of the income goes towards the children’s upbringing. Equally, the same assists in showing that the decreasing expenditure between 60 and 70 years of age is due to the growing up of children who can now depend on themselves.