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This question came out as a multiple-choice in my A-Level Economics exam. The answer choices were:

A) Rising income inequality B) Increased availability of consumer goods C) Rising medical expenses

Without actual information, the question is debatable. I am not sure why this we were asked to hypothesise without adequate information.

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  • $\begingroup$ Isn't there any other explanation like people becoming less well off? $\endgroup$ – Deer Hunter May 30 '15 at 22:24
  • $\begingroup$ Hence, my confusion over why it appeared in a high-stakes exam for university admissions. $\endgroup$ – Maxis Jaisi Jun 1 '15 at 7:47
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I couldn't say what was the actual explanation but Increased availability of consumer goods could deliver this result. Say people in the USSR expected that eventually there would be a consumer revolution where their choice of goods would be better. Then utility would look like something like this: $$ U(c_1, c_2, c_3) = ln(c_1) + \beta \cdot \xi \cdot ln( c_2) + \beta^2 \cdot \xi \cdot ln( c_3)$$

where $c_i$ is the consumption in period $i$, $\beta$ is the discount rate, and $\xi > 1$ indicates how much better consumption is in time 2 than 1. A higher value of $\xi$, meaning a greater improvement in consumption acts like a higher value of $\beta$, meaning lower discounting of future consumption in period $1$. That means that households will (all else equal) save more in period 1. In period 2 there is no expected increase in the quality of consumption, only the standard time discounting differentiates consumption in the present and future, and so the savings rate (relative to period 1) falls, just as it would if $\beta$ fell.

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Given that the question was given as a multiple choice question, I'd use the process of elimination to eliminate answers, leaving you with the best answer of the answers provided. So to Deer Hunter's point there may be better answers, but for the sake of the test, we can ignore them.

Answer A "Rising income inequality" doesn't make sense as a potential answer, because an increase in income inequality doesn't decrease the amount of money available to be saved in aggregate. Sure if you look at someone who is on the unfortunate end of the increase in income inequality they would have less money, and thus less money to save. But at the same time what about the rich, they have more money in this new more unequal distribution of income, just as the poor were less likely to save because they have less money aren't the rich more likely to save because they have more money. You agree with that last sentence or not, the thing to take away is that changes in inequality are changes in the distribution of the income but not necessarily changes in the amount available in aggregate. Since you are being asked about an aggregate number inequality on it's own isn't a great explanation. Plus, this doesn't really tie in any economic theory you would have learned in your A-levels.

Answer C "Rising Medical Expenses" you may think makes some sense because if people have to spend more money on Medical expenses that money has to come from somewhere. While that is true, does it have to come from savings? Couldn't this come from consumption? Couldn't people cut back on spending on other things to cover this increase spending on medical expenses. Again this on it's own doesn't explain why savings would decrease. Another red flag is, how big an effect would a increase in medical expenses have. How many people are sick and would be expected to be paying these increased medical expenses? Would this effect everyone and thus the aggregate numbers or just a subset of people. How much would these medical expense increases need to be and how many people would have to be paying them to make a noticeable impact on aggregate savings? So this answer is better than A, but still not great

Answer B "Increased availability of consumer goods", Hmmm... what does that mean. Well there is an increase in the availability of some goods. What's another word for availability... Supply. Oh it's a increase of supply! That sounds like Economic theory! what would that do, well supply increases which shifts it to the right which means the equilibrium point moves along the demand curve, which means the price should fall, and the quantity of consumer goods consumed should increase. And this means that the total amount spend on consumer goods: Price * quantityDemand will... We don't know. It depends on slope of the demand curve, which will depend on the elasticity of demand for the consumer goods. But what do we know... we know that consumers should be buying more consumer goods, the price for those consumer goods should be falling, but we don't know if the total amount people are spending on consumer goods is increasing or decreasing. Hmmm... but what does any of this have to do with savings. How are savings and consumption related... Hmmm... probably something to do with Marginal something, because well it's your A-levels and economics everything has to do with the Marginal-something-a-rather. Oh yeah Marginal-propensity-to-consume which is equal to 1 - Marginal-propensity-to-save. That's the thing where any given dollar can either be spend or consumed, those are the only options, because that is how we defined saving as not spending. So your Marginal-propensity-to-consume is the probability you are going to spend your next dollar on consumption. Marginal-propensity-to-save is the probability you are going to save your next dollar. Well if we know people are buying more consumer goods, and the price of those consumer goods is falling, the probability that there going to spend there next dollar is likely higher, and the probability they are going to save there next dollar is likely lower. Thus people are less likely to save and it makes sense that savings should decrease. BOOM THIS IS THE ANSWER!!!!

So I'm confident B was the answer they were looking for. I hope that helped, and that that longwinded explanation was entertaining, and didn't seem sarcastic. I genuinely think I'm hilarious. So that makes one of us :P .

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