Customer Relating Theories
Another application of the theory pertains to The Permanent Income Theory of Consumption which states that there is a direct positive relationship between the people's consumption and their income. Friedman believed that people not only consume depending upon their current income, but also considering their future income. Analysis of future income in his work is due to the expectations that people have about their future, so the concept directly relates to the rational expectations theory. The specific model of consumption and income has been tested time and again and results have varied greatly, as the studies show that the model works, but imperfectly. It can be argued to overpower the above mentioned point that many people have certain consumption habits and if they stick to their habits, it becomes literally improbable for them to care about their resources and income. Many such cases happen with addicts or people who abuse drugs or alcohol. Rational expectations theory can also be applied to the Expectation Error Models of the Business Cycle, which states that errors in people's forecasts are a major cause of business fluctuations. Phillips curve shows the inverse relationship between unemployment and inflation, where there is a non-accelerating inflation rate of unemployment. The PC which is the long red line changes in the long run because of the change in expectations and thus only a single rate of unemployment was consistent with the inflation rate. If the unemployment rate stays behind the red line inflationary expectations will rise which will tale the short term PC upwards as indicated by B.
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