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1. The pension of a retired person as a proportion of income when in employment. The higher is the replacement ratio the stronger is the incentive to retire. Conversely, a worker may postpone retirement if the current replacement ratio is too low. A target replacement ratio is used as a guide in pension planning. 2. The income of an unemployed worker as a proportion of income when in work. If this ratio is too high it gives a disincentive to accept job offers: allowing for the cost of travel to work and other working expenses, and the value of leisure, a replacement ratio below 1 is needed to maintain incentives to work. Too high a replacement ratio may perpetuate unemployment, while too low a ratio inflicts suffering on the unemployed and their families. In practice replacement ratios vary widely, as income support for the unemployed is based on family size while wages are not.
Reference: Oxford Press Dictonary of Economics, 5th edt.
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