Principles of Economics- Mankiw (5th) 433

Principles of Economics- Mankiw (5th) 433 - CHAPTER 20...

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CHAPTER 20 INCOME INEQUALITY AND POVERTY 445 Florida frost drives up the price of oranges, and California orange growers see their incomes temporarily rise. The next year the reverse might happen. Just as people can borrow and lend to smooth out life cycle variation in in- come, they can also borrow and lend to smooth out transitory variation in income. When California orange growers experience a good year, they would be foolish to spend all of their additional income. Instead, they save some of it, knowing that their good fortune is unlikely to persist. Similarly, the Florida orange growers re- spond to their temporarily low incomes by drawing down their savings or by bor- rowing. To the extent that a family saves and borrows to buffer itself from transitory changes in income, these changes do not affect its standard of living. A family’s ability to buy goods and services depends largely on its permanent in- come, which is its normal, or average, income. To gauge inequality of living standards, the distribution of permanent income
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