Question

Explain the difference between absolute and relative poverty and identify and explain the main determinants of consumption, investment and saving in an economy.
Word Limit: 300 words

Answer 1

Absolute poverty is a situation in which a section of society lacks basic amentities like food, shelter, healthcare etc.

Relative poverty is a situation in which a section of households receive 50% less than average household incomes. That is they have some money but still not enough to afford more than basics.

Consumption is mainly determined by interest rate and disposable income. Higher the income, more will the demand for to spend on consumption. Thus disposable income and consumption is positively related. In contrast, interest rate on assets like bonds is negatively related with consumption. Higher the interest rate , higher is the cost of holding money. So people will demand less money resulting in lower spending on consumption.

The main determinants of investment are expectations of future profitability profitability and interest rate. Higher the expectations of future profitability, more will be the investment. Lower the interest rate, more will be the investment because of lower cost of borrowing.

Saving also depends on disposable income and interest rate. Higher the rate of interest, more will be the saving and thus consumption. People will save more to get profit from higher interest rate. Rise in the income is not just whole spent on consumption but a proportion of it (equal to mps) is saved.