The permanent income of an individual or household refers to the anticipated/planned average income over a long period of time. It differs from short run income in the following important ways:
- Short run income is more affected by unanticipated random fluctuations, whereas for permanent income, averaging out over a longer period makes the random fluctuation less important.
- Short run income is affected by periodic seasonal fluctuation, whereas permanent income averages out the seasonal fluctuations.
- Short run income is unduly influenced by one's current life stage, whereas permanent income averages over various life stages. For instance, a person studying a subject with highly lucrative career opportunities may have a negative short run income but a highly positive permanent income.
The permanent income hypothesis, proposed by Milton Friedman, states that the average propensity to consume and average propensity to save are influenced more by permanent income than by the transitory component of income (which is subject to random and seasonal fluctuations).