Question

Explain why poverty may inhibit economic growth.

This is for an international economics course. The chapter is on poverty, inequality, and development.

Answer 1

By increasing inequality while holding the mean constant will usually increase poverty. Thus, if a rising mean is accompanied by rising inequality, the poverty reduction impact from growth will be attenuated.

There are two main ways in which poverty affects a typical economy. First, it reduces the level of aggregate demand in the economy, making the economy poorer than it could be. Second, it typically requires the government to institute some sort of welfare programs, leading to increased government spending.

When there is poverty in an economy, governments typically feel compelled to act. They feel they have to do something to help protect the poor from the effects of poverty. In the US, for example, the government provides poorer people with things like health care and help with buying food.

Perhaps more importantly, poverty can reduce aggregate demand in an economy. Poor people cannot afford to buy as many goods and services as people with more income can. When a country has a high number of poor people, its population as a whole cannot buy as much as it would be able to if there were less poverty. This means there is less demand for goods or services produced in that country. Because of this reduced aggregate demand, the country’s GDP will be lower than it would be if there were less poverty. This can severely restrict the country’s economic potential.