Question

Explain the difference between the consumption smoothing provided by a social insurance program and the replacement rate provided by the program.

Answer 1

consumption smoothening is the reffer to the condition in which people can cosume smoothly without any difficulty. To illustrate it we must understand that about sates of life which can be classified into two parts, In first part a person is healthy and can earn enough to mee his consumption which are low in comparison with his income so people in stage one spends alot on wasteful consumption instead of saving for the uncertain future where as in the another second part the person is not able to earn enough due to any uncertainty but his consumption rises and his income is not enough to meet all its demand, In this stage, people demand full insurance to make smooth consumption. therefore it can be said that insurance is the tool by which one can insure his smooth consumption in all state of life even if life suffer with an uncertainty.

Replacement rate can be understood by a simple example in old age a person would not be able to earn income to meet his future demands so he starts investing in some retirement plan by considering the replacement rate, which insures him that he will have enough income in coming future to meet his all demands as per his standard of living, replacement rate is differ from person to person as per his standard of living. Replacement rate is the percentage of person pre retirement income that he will have after retirement by his insurance plan to meet future demands. By replacement rate we can understand the effectiveness of the insurance plan as it can be used by a person to estimate his income after retirement by his insurance plan.