Question

Suppose that a family saves and borrows to buffer itself against changes in income. These actions relate to which problem in measuring inequality?

a. economic mobility
b. in-kind transfers
c. transitory versus permanent income
d. negative income tax

Answer 1

The concept of saving and borrowing as a response to income changes is connected to the transitory versus permanent income issue in measuring economic inequality. This distinction influences consumption behaviors and presents challenges in assessing inequality levels. Option number C is correct.

Step-by-step explanation:

The actions of a family saving and borrowing to buffer against changes in income relates to the transitory versus permanent income problem in measuring inequality. When a family adjusts their savings and borrowing, they are responding to changes in income that may be temporary or permanent.

The distinction is crucial, as it affects their consumption behavior and the economic inequality measurements. For example, a temporary increase in income might lead to modest changes in consumption due to the expectation that the higher income will not persist. Conversely, a permanent increase is likely to result in a larger adjustment in consumption and savings. These dynamics complicate the evaluation of inequality because they reflect individuals' expectations about their future income and thus influence their current economic decisions.