Deck 16: Expectations, Consumption and Investment

Question 1

Which of the following is evidence that consumption depends on total wealth, and not just on current income?

A) A series of phased- in tax cuts announced by the government causes little change in consumption.
B) People save very little for their retirement.
C) Banks will not always lend money to those who want to consume more than their income.
D) The anticipation of future financial distress makes some people reluctant to borrow.
E) A decrease in consumer confidence, with unchanged current income, often causes total consumption spending to fall.

Answer 1

A decrease in consumer confidence, with unchanged current income, often causes total consumption spending to fall.

Question 2

Which of the following will cause an increase in current consumption?

A) An increase in financial wealth.
B) An increase in current disposable income.
C) An increase in human wealth.
D) All of the above.
E) Both A and B.

Answer 2

All of the above.

Question 3

Which of the following describes the "depreciation rate"?

A) The difference between current and expected income.
B) How much usefulness a machine loses from year to year.
C) The interest rate that should be used in present discounted value calculations.
D) The difference between current and expected profits.
E) The rate at which consumers deplete their total wealth in retirement.

Answer 3

How much usefulness a machine loses from year to year.

Question 4

A panel dataset study of consumption behaviour by Venti and Wise for the U.S. finds that:

A) most people are indifferent about saving sufficiently for retirement.
B) most people are forward- looking with many in the top income distribution leaving bequests.
C) most people are not able to save enough for retirement because of bad luck.
D) most people are backward- looking about consumption.
E) most people plan to a limited degree for retirement while concentrating on current consumption.

Question 5

The user cost of capital is represented by which of the following variables?

A) IIt/(rt + 6).
B) 1/(rt + 6).
C) rt.
D) rt + 6.
E) IIt.

Question 6

The rental cost/ user cost of capital will increase when:

A) the expected profit from the machine increases.
B) the rate of depreciation decreases.
C) the expected profit from the machine decreases.
D) the real interest rate increases.
E) the expected level of sales increases.

Question 7

Suppose there is a decrease in profitability. This suggests that:

A) the real interest rate has decreased.
B) firms have decreased their expectations of future profits.
C) the rate of depreciation has decreased.
D) All of the above.
E) None of the above.

Question 8

Which of the following statements is true?

A) A change in sales should have more impact on current investment if it is expected to be permanent rather than temporary.
B) Investment and consumption contribute equally to output fluctuations.
C) On a percentage basis, investment is more volatile than consumption.
D) All of the above.
E) None of the above.

Question 9

As of 2007, some analysts were concerned that there was a "bubble" in the Australian housing market. Suppose there is a decrease in real estate prices. This fall in real estate prices would have the most direct effect on which of the following types of wealth?

A) Financial wealth.
B) Housing wealth.
C) Human wealth.
D) Labour wealth.
E) Investment wealth.

Question 10

A fall in sales will generally cause:

A) initial decreases followed by increases in profit per unit of capital.
B) a decrease in profit per unit of capital.
C) no change in profit per unit of capital.
D) ambiguous effects on profit per unit of capital.
E) an increase in profit per unit of capital.

Question 11

Which of the following is a reason that consumption depends on current income, and not just on total wealth?

A) The anticipation of future financial distress makes some people reluctant to borrow.
B) Low income people may prefer to postpone some consumption until later years, when their incomes are higher.
C) Banks will not always lend money to those who want to consume more than their income.
D) All of the above.
E) None of the above.

Question 12

A decrease in which of the following variables will cause a decrease in the user cost of capital?

A) t Kt.
B) IIt.
C) II e .
D) Yt.
E) rt.

Question 13

Which of the following events would likely cause the largest decrease in current consumption?

A) A one- time decrease in income (e.g. a bonus) of $4000.
B) A permanent decrease in annual salary of $2000.
C) A one- time tax increase of $4000.
D) Both A and C.
E) Both B and C.

Question 14

An increase in which of the following variables should cause an increase in profit per unit of capital?

A) The ratio of total sales to the capital stock.
B) Total sales.
C) The ratio of total sales to total wages and salaries.
D) The capital stock.
E) Total wages and salaries.

Question 15

Which of the following would cause a decrease in human wealth?

A) A decrease in the value of one's house.
B) A decrease in the value of one's stock portfolio.
C) A permanent decrease in salary.
D) All of the above.
E) None of the above.

Question 16

Assume the following: (1) the real cost of a unit of capital is one; (2) the unit of capital is expected to increase a firm's real profit by $10,000 each year, and depreciate by 10% each year; and (3) the real interest rate is 2%. What is the "user cost" or "rental cost" of this unit of capital?

A) 0.09.
B) 0.03.
C) 0.12.
D) 0.15.
E) 0.18.

Question 17

Which of the following will occur when the capital stock increases?

A) There will be no change in profit per unit of capital.
B) Profit per unit of capital will decrease.
C) Profit per unit of capital will increase.
D) Profit per unit of capital initially increases followed by decreases.
E) There will be an ambiguous effect on profit per unit of capital.

Question 18

Suppose that, when the price of steel drops, steel companies tend to cut back on investment in their non- steel activities more than other firms in these same non- steel activities. This would support the idea that:

A) business firms do not care about interest rates.
B) cash flow does not matter for investment.
C) business firms do not care about profit.
D) business firms do not use discounting.
E) cash flow matters for investment.

Question 19

The fall in stock prices during the global crisis in 2008 would have the most direct effect on which of the following types of wealth?

A) Financial wealth.
B) Housing wealth.
C) Human wealth.
D) Labour wealth.
E) Investment wealth.

Question 20

An increase in which of the following variables will cause an increase in the user cost of capital?

A) t 6.
B) Yt.
C) Kt.
D) IIt.
E) II e .

Question 21

The data shows that total profit in the Australian economy:

A) tends to increase in even years, and decrease in odd years, although no one can explain why.
B) tends to decrease in recessions, increase in expansions.
C) is not influenced by the business cycle.
D) has decreased steadily over time.
E) tends to increase in recessions, decrease in expansions.

Question 22

A painting is currently worth $150,000, and is expected to maintain its real value for four years. The real interest rate is expected to remain constant at 8%. What is the present value of the painting's expected price at the end of the fourth year?

A) $100,254.
B) $90,254.
C) $80,254.
D) $110,254.
E) $70,254.

Question 23

Which of the following represents human wealth?

A) Wealth that cannot be taken from a person, by law.
B) Financial wealth minus housing wealth.
C) The present discounted value of expected future after- tax labour income.
D) Total wealth minus housing wealth.
E) The sum of financial and housing wealth.

Question 24

Suppose an individual experiences a $25,000 decrease in real income and the individual believes this decrease in income is permanent. Economic theory suggests that this individual's current consumption will:

A) decrease, remain unchanged, or increase, depending on the value of the real interest rate.
B) decrease by more than $25,000.
C) decrease at most by $25,000.
D) decrease or remain unchanged, depending on the value of the real interest rate.
E) decrease by less than $25,000.

Question 25

Which of the following statements about consumption and investment is correct?

A) A temporary change in income will have a relatively larger effect on consumption than on investment.
B) A permanent change in income will have a relatively larger effect on consumption than on investment.
C) Consumption is more volatile than investment.
D) Investment and consumption exhibit approximately the same degree of volatility.
E) Investment is more volatile than consumption.

Question 26

Assume that consumption decisions are made according to the permanent income theory. Which of the following would lead to the largest increase in current consumption?

A) Winning $10,000 in the lottery.
B) Obtaining $10,000 by winning a lawsuit.
C) Getting a one- time $10,000 bonus from your employer.
D) Taking a new job with a salary that is $10,000 higher than your current salary.
E) Inheriting $10,000 from a relative.

Question 27

The study by Venti and Wise shows that most of the wealth of people aged 65- 69 consists of:

A) stocks and bonds.
B) social security benefits.
C) home equity.
D) personal retirement assets.
E) employer- provided pension.

Question 28

Suppose you are given a rare antique painting by a long- lost relative. The value of this rare antique painting would be included in which of the following?

A) Financial wealth.
B) Housing wealth.
C) Human wealth.
D) Labour wealth.
E) Investment wealth.

Question 29

Which of the following represents non- human wealth?

A) Total wealth minus housing wealth.
B) Total wealth minus the present discounted value of expected future after- tax labour income.
C) Financial wealth minus housing wealth.
D) Wealth that cannot be taken from a person, by law.
E) Total wealth minus financial wealth.

Question 30

Which of the following individuals is responsible for developing the permanent income theory of consumption?

A) Keynes.
B) Friedman.
C) Lucas.
D) Modigliani.
E) Sargent.

Question 31

Human wealth is a function (i.e., affected by changes in) of which of the following variables?

A) Current interest rates.
B) Future expected income.
C) Future expected taxes.
D) All of the above.
E) None of the above.

Question 32

The data for Australia show that investment and profits:

A) have a clear positive relationship.
B) are positively related during recessions, and negatively related during expansions.
C) are positively related during expansions, and negatively related during recessions.
D) have a strong negative relationship.
E) move independently.

Question 33

Consumption is most likely to respond one- for- one with changes in current income when:

A) people are able to borrow as much as they wish, as long as they pay it back.
B) the change in current income is caused by the business cycle.
C) people believe the change in their current income is permanent.
D) the change in current income results from a one- time government handout.
E) people believe the change in their current income is temporary.

Question 34

The rental cost/ user cost of capital will decrease when:

A) the expected profit from the machine decreases.
B) the real interest rate increases.
C) the expected level of sales decreases.
D) the rate of depreciation decreases.
E) the expected profit from the machine increases.

Question 35

Assume that firms experience an increase in sales. We would expect that this increase in sales will cause:

A) ambiguous effects on profit per unit of capital.
B) initial increases followed by decreases in profit per unit of capital.
C) an increase in profit per unit of capital.
D) no change in profit per unit of capital.
E) a decrease in profit per unit of capital.

Question 36

Which of the following individuals is responsible for developing the life cycle theory of consumption?

A) Friedman.
B) Keynes.
C) Lucas.
D) Sargent.
E) Modigliani.

Question 37

Suppose current sales decrease by $150 million. Investment theory suggests that current investment must:

A) decrease by more than $150 million.
B) decrease by less than $150 million.
C) decrease by about $150 million.
D) increase, but by less than $150 million.
E) More information is required.

Question 38

Suppose there is an income tax cut. This tax cut would have a direct effect on which of the following?

A) Financial wealth.
B) Housing wealth.
C) Human wealth.
D) Labour wealth.
E) Investment wealth.

Question 39

A change in which of the following variables would affect the cash flow for a firm?

A) Current profit.
B) Current expenditure on plant and equipment.
C) Total cost.
D) Total sales revenue.
E) Expected future profit.

Question 40

Which of the following people-none of whom has any financial or housing wealth-is most likely to be spending all of their current income?

A) A high income person expecting to retire soon, and live for a long time afterward.
B) A low income person expecting continued low income throughout life.
C) A low income person expecting a dramatic rise in income in the future.
D) A high income person expecting a dramatic drop in income in the future.
E) A high income person expecting continued high income throughout life.

Question 41

The "life cycle" and "permanent income" theories of consumption share which of the following features?

A) Consumption remains stable on a permanent basis.
B) Consumption spending depends on income, rather than wealth.
C) Consumption spending should fluctuate widely from year to year.
D) Consumers look ahead to the future in making current spending decisions.
E) Consumption decisions are based on how well the stock market performs.

Question 42

Suppose there is an increase in cash flow. This suggests that:

A) the real interest rate has increased.
B) the rate of depreciation has increased.
C) current profits have increased.
D) firms have decreased their expectations of future profits.
E) All of the above.

Question 43

Explain what decisions and calculations a very foresighted consumer must make to determine her consumption decisions in any period.

Question 44

A decrease in the rate of depreciation will cause the discounted present value of expected profits to:

A) decrease.
B) increase.
C) remain unchanged if the real interest rate decreases by the same amount.
D) All of the above.
E) None of the above.

Question 45

Explain each of the determinants of the present value of expected profits from buying a new machine.

Question 46

Suppose there is an increase in income. This increase in income would have a direct effect on which of the following?

A) Financial wealth.
B) Housing wealth.
C) Human wealth.
D) Labour wealth.
E) Investment wealth.

Question 47

Explain the difference between "profitability" and "cash flow".

Question 48

Which of the following best defines total wealth?

A) Human wealth only.
B) Non- human wealth only.
C) Non- human wealth and human wealth.
D) Financial wealth and housing wealth only.
E) Financial wealth only.

Question 49

Suppose individuals expect future output to be lower and future interest rates to be lower. Given this information, how will individuals alter consumption in the current period? Explain.

Question 50

Explain why consumption is less volatile than investment.

Question 51

Discuss the various components of wealth.

Question 52

Explain why consumption and investment contribute roughly equally to output fluctuations when investment exhibits higher volatility than consumption.

Question 53

Which of the following will occur when the capital stock falls?

A) There will be no change in profit per unit of capital.
B) Profit per unit of capital will decrease.
C) Profit per unit of capital will increase.
D) Profit per unit of capital initially decreases followed by increases.
E) There will be an ambiguous effect on profit per unit of capital.

Question 54

Explain why current consumption might change even if current income does not change.

Question 55

Explain how a change in expected future output could change current output.

Question 56

First, briefly explain what the user cost or rental cost of capital represents. Second, explain what factors would cause an increase in user cost or rental cost of capital.

Question 57

Explain why current consumption is likely to respond less than one for one to changes in current income.

Question 58

Explain what decisions and calculations a firm must make when it is considering the purchase of new capital (i.e., making an investment decision).

Question 59

Suppose firms expect future output to be higher and future interest rates to be higher. Given this information, how will firms alter investment in the current period? Explain.