Deck 10: Consumption Demand

Question 1

For the past 30 years in the United States, the long- and short-run marginal propensities to consume have been estimated to be

A) 0.72 and 0.94, respectively.
B) 11.2 and 4.1, respectively.
C) 0.94 and 0.77, respectively.
D) identical and equal to 0.94.
E) too volatile to attribute to a single number.

Answer 1

0.94 and 0.77, respectively.

Question 2

Modern forward-looking theories of consumption

A) are founded on the pioneering work done by Milton Friedman and Franco Modigliani on the permanent income theory and the life cycle theory, respectively.
B) are based on consumption depending on current disposable income, current wealth, and expected paths of disposable income and wealth in the future.
C) assert that individuals make long-term consumption decisions each year, using as much information about the present and the future as possible.
D) do not preclude individuals' changing consumption plans as new information presents itself.
E) all of the above.

Answer 2

all of the above.

Question 3

An intuitive explanation of the observed discrepancy between short- and long-run marginal propensities to consume must focus on why

A) consumption falls by less than income in the short run but eventually achieves over 90 percent of income's decline.
B) consumption climbs slower than income in the short run but eventually exhausts over 90 percent of income's increase.
C) consumption moves more slowly in either direction than income in the short run but eventually matches either move almost exactly.
D) a and b.
E) none of the above.

Answer 3

a and b.

Question 4

Statistical studies of the U.S. economy over the past three decades suggests a long-run marginal propensity to consume of

A) 11.2.
B) 0.71.
C) 0.51.
D) 0.94.
E) 1.01.

Question 5

Which of the following rankings accurately lists the major components of consumption expenditure in terms of their volatility over the business cycle?

A) Nondurables > durables > services
B) Durables > nondurables > services
C) Durables > services > nondurables
D) Services > durables > nondurables
E) Nondurables > services > durables

Question 6

Forecast errors from the simple Keynesian consumption function, while less than $65 billion or 3 percent) in either direction,

A) are really quite large for forecasting and policy purposes.
B) are really quite small for forecasting and policy purposes.
C) can result from swings in confidence or changes in tax policy.
D) both a and b.
E) both a and c.

Question 7

Errors made by researchers using the long-term estimate of the marginal propensity to consume to predict short-term movement in consumption can be extremely large. It is important, therefore, to understand when those errors might occur. If you were to draw the simple Keynesian consumption with MPC = 0.94 on a piece of graph paper, then you would expect to plot

A) the combination of consumption and GDP for 1973 above the line.
B) the combination of consumption for 1983 below the line.
C) the combination of consumption and GDP for 1975 above the line.
D) the combination of consumption and GDP for 1946 below the line.
E) none of the above.

Question 8

Of the major components of consumption expenditure, which of the
Following has been increasing most rapidly over the past decade or so in the United States?

A) Durables
B) Defense expenditure
C) Nondurables
D) Depreciation expenditure
E) Services

Question 9

Real GDP in the United States

A) exceeds disposable personal income by 40 percent, because GDP includes taxes, retained earnings, and depreciation expenditures that are not part of personal income.
B) falls short of disposable personal income by 40 percent, because personal income includes transfer payments that are not directly linked to production.
C) almost exactly equals disposable personal income, because depreciation expenses are such a small fraction of gross investment in most years.
D) exceeds disposable personal income by over 50 percent because of the size of the federal budget.
E) none of the above.

Question 10

The difference between personal disposable income and GDP declines during recessions and expands during boom times because

A) revenues collected by progressive income taxes climb faster than GDP during economic booms.
B) unemployment compensation payments and other transfer programs expand during recessions.
C) revenues collected by progressive income taxes fall faster than GDP during recessions.
D) unemployment compensation payments and other transfer programs contract during economic booms.
E) all of the above.

Question 11

Knowing the desired size of the bequest is important in predicting the path of future consumption,

A) but unfortunately it is inconsistent with the basic assumptions of the permanent income hypothesis.
B) but unfortunately it is inconsistent with the basic assumptions of both the permanent income hypothesis and the life cycle hypothesis.
C) but not knowing its precise size does little to undermine the general implications of any of the forward-looking consumption theories.
D) but theories that explain bequest behavior are totally inconsistent with any forward-looking consumption theory.
E) none of the above.

Question 12

Suppose that an individual receives an unexpected, one-time windfall of
$1,000. To determine its effect on future consumption,

A) preferences about the desirability of both steady consumption and the desired size of the bequest are required.
B) it would be necessary to know the desired size of the bequest, but the desirability of steady consumption is immaterial.
C) it would be necessary to know the value ascribed to steady consumption, but the desired size of the bequest is immaterial.
D) neither the desirability of steady consumption nor the desired size of the bequest is material because $1,000 is too small a sum to be affected by either.
E) none of the above.

Question 13

The short-run marginal propensity to consume is estimated on the basis of

A) a straight-line equation that most accurately describes consumption as a function of personal disposable income.
B) a curved-line equation that most accurately describes consumption as a function of personal disposable income.
C) a straight-line equation that most accurately describes year-to-year changes in consumption as a function of year-to-year changes in personal disposable income.
D) a curved-line equation that most accurately describes year-to-year changes in consumption as a function of year-to-year changes in personal disposable income.
E) none of the above.

Question 14

Experience for the United States shows that

A) consumption and GDP grow at about the same rate over the long term with GDP being less volatile over the short-term business cycle.
B) consumption grows slower than GDP over the long term with consumption being less volatile over the short-term business cycle.
C) consumption grows faster than GDP over the long term with consumption being more volatile over the short-term business cycle.
D) consumption and GDP grow at about the same rate over the long term with GDP being more volatile over the short-term business cycle.
E) consumption grows faster than GDP over the long term with GDP being more volatile over the short-term business cycle.

Question 15

The recession of the early 1980s saw

A) a mild drop in the rate of growth of GDP coupled with a surprisingly large contraction in consumption expenditure.
B) one of the most severe declines in GDP of the past 50 years matched in percentage terms by a corresponding reduction in consumption expenditure.
C) one of the most severe recessions of the past 50 years punctuated only briefly by a small reduction in consumption.
D) a mild contraction in the rate of growth of GDP matched by a small contraction in consumption expenditure.
E) none of the above.

Question 16

One reason why consumption expenditure is less volatile than GDP is that

A) personal disposable income is more volatile than GDP.
B) personal disposable income is less volatile than GDP.
C) the progressive income tax structure of the United States is too weak to generate higher and lower collections during booms and recessions, respectively.
D) retained corporate earnings increase during recessions because firms use the slow times to retool for the next upturn.
E) none of the above because the statement is false.

Question 17

The short-run marginal propensity to consume can be derived statistically by calculating how

A) the level of consumption responds to changes in the level of disposable income.
B) changes in consumption respond to changes in disposable income from year to year.
C) consumption is correlated to disposable income on a quarterly basis.
D) changes in consumption of less durable goods respond to changes in disposable income.
E) none of the above.

Question 18

Suppose that you were to incorporate the repayment of a consumer loan interest and principal into an intertemporal budget constraint. The loan would be added as income in the year received and

A) principal and interest would all be subtracted in the year the loan was finally paid off.
B) interest and principal would be subtracted in each year according to that schedule by which the loan was to be paid off.
C) interest would be subtracted immediately on receipt of the loan, but principal would be subtracted only in the year that the loan was finally paid off.
D) only interest would be subtracted and that only for the duration of the loan.
E) none of the above.

Question 19

The distinction between consumption and consumption expenditures, although subtle, becomes important in the case of

A) services, since they are rapidly becoming a much larger portion of consumption.
B) nondurables, since they are becoming a much larger portion of consumption.
C) durables, since they are purchased erratically but consumed more or less continuously over time.
D) both a and b.
E) a, b, and c.

Question 20

Because the long-run marginal propensity to consume is

A) smaller than the short-run marginal propensity to consume; consumption is more volatile over the business cycle than personal disposable income.
B) larger than the short-run marginal propensity to consume; consumption is less volatile over the business cycle than personal disposable income.
C) larger than the short-run marginal propensity to consume; consumption is more volatile over the business cycle than personal disposable income.
D) smaller than the short-run marginal propensity to consume; consumption is less volatile over the business cycle than personal disposable income.
E) identical to the short-run marginal propensity to consume.

Question 21

It has been argued that, "A tax cut must be followed later by a tax increase to pay for the resulting deficit" is the self-fulfilling prophecy of those who use it to predict that an income windfall from a tax reduction must be temporary. The argument can be supported by

A) appealing to forward-looking consumption theory, which predicts that a temporary increase in income produces only a small increase in consumption.
B) noting that small consumption increases produce very little economic stimulus.
C) recalling that larger than expected gaps between actual and potential GDP mean larger deficits spawned by enlarged transfer programs and reduced tax revenues.
D) all of the above.
E) none of the above.

Question 22

If permanent income is always taken to equal disposable income in the current year, then a consumption function of the form C = a + bYDp)

A) reveals a long-run marginal propensity to consume that is larger than the short-run marginal propensity to consume.
B) reveals a long-run marginal propensity to consume that is exactly equal to the short-run marginal propensity to consume.
C) reveals a long-run marginal propensity to consume that is smaller than the short-run marginal propensity to consume.
D) defines short- and long-run marginal propensities to consume, to be sure, but insufficient information has been provided to compare them.
E) is difficult to specify in times of uncertain income.

Question 23

Let C = 100 + 0.9YDp) reflect a consumption function with YDp) representing the individual's view of permanent disposable income; let permanent income be defined by YDp) = 0.5YD-0) + 0.25YD-1) +
0)25YD-2) with YD-j) notationally representing disposable income lagged j years. If disposable income were $10,000 in each of three successive years-0, 1, and 2-then consumption in year 4 would equal

A) $9,000.
B) $9,100.
C) $10,000.
D) $10,100.
E) an amount that cannot be determined from the information provided.

Question 24

Given a 20-year planning horizon and a real interest rate of 0 percent, an individual receiving a $1,000 increase in income would display a marginal propensity to consume

A) of 1 if the increase is thought to be permanent and 0.5 if it is viewed as a one-time windfall.
B) of 1 if the increase is thought to be permanent and 0.05 if it is viewed as a one-time windfall.
C) that is higher if the increase is permanent than temporary, but it is impossible to specify exact numbers with the information provided.
D) that is lower if the increase is permanent than temporary, but it is impossible to specify exact numbers with the information provided.
E) none of the above.

Question 25

Suppose that an individual anticipated that the next calendar year's income would be $1,000 higher than this year's. Facing a real interest rate of 0 percent and a 20-year planning horizon, you would expect her annual real consumption to

A) increase by $900 if the increase were permanent and $90 if it were a one-shot deal.
B) increase by $1,000 if the increase were permanent and $100 if it were a one-shot deal.
C) increase by $950 if the increase were permanent and $50 if it were a one-shot deal.
D) remain the same for one year and then increase by $1,000 if the increase were permanent and by $50 if it were temporary.
E) none of the above.

Question 26

Which of the following statements is an accurate statement of an implication of the forward-looking theory of consumption?

A) The marginal propensity to consume tends to be smaller than it would be otherwise because people view at least part of every income change as temporary.
B) Sensitivity of consumption to the interest rate tends to make the IS curve flatter than it would be otherwise.
C) Sensitivity of saving to the interest rate tends to make the marginal propensity to consume smaller than it would be otherwise.
D) The likely effect of the implied reduction in the short-run marginal propensity to consume tends to make the IS curve steeper than it would be otherwise.
E) All of the above.

Question 27

According to the statistical model of Ando and Modigliani, it may be possible to explain the reduction in consumption that marked 1973 in terms of

A) a sudden reduction in the long-run marginal propensity to consume.
B) a sudden increase in the short-run marginal propensity to consume.
C) a steep decline in the value of assets in which people hold their wealth.
D) an inability of most consumers to see the temporary nature of the oil shock.
E) an increase in saving caused by individuals wanting to prepare for an anticipated recovery from the oil shock in the medium term.

Question 28

Let C = 100 + 0.9YDp) be the consumption function for two people, A and B, with YDp) notationally indicating their view of their permanent income. Summarize that view by defining YDp) = 0.5YD-0) + 0.25YD-1) + 0.25YD-2) with YD-j) notationally representing disposable income lagged j years. If three successive years of disposable income equaling $10,000 were followed by a year of A earning $11,000 and B earning $15,000, then the marginal propensity to consume would equal

A) 0.45 for both A and B.
B) 0.45 for A and 0.4 for B.
C) 0.4 for A and 0.45 for B.
D) 0.9 for both A and B.
E) none of the above.

Question 29

Suppose someone anticipates a large increase in income sometime during the n ext ye a r. The more like ly it ap p e a rs that that increase will be perm a n e n t ,

A) the larger is the increase in consumption even before the increment arrives.
B) the larger is the increase in consumption when the increment arrives.
C) the larger is the increase in income in every year after the increment arrives.
D) all of the above.
E) none of the above.

Question 30

Statistical investigations of the marginal propensity to consume have generated estimates that

A) match the predictions of the theory pretty well in both the long run and the short run.
B) match the predictions of the theory in the short run but fall below numbers that would be consistent with the theory in the long run.
C) fall short of numbers that would be consistent with the theory in both the long run and the short run.
D) lie above numbers that would be consistent with the theory in the long run and below numbers that would be consistent with the theory in the short run.
E) none of the above.

Question 31

Preferences for steady consumption paths over variable consumption paths mean that

A) any permanent change in an individual's disposable income must generate either a change in the desired bequest or a comparable change in consumption.
B) the applicable marginal propensity to consume out of a permanent change in an individual's disposable income must be close to 1.
C) any temporary change in an individual's disposable income must generate only a small change in yearly consumption if it is to be spread out smoothly over a foreseeable lifetime.
D) all of the above.
E) a and c only.

Question 32

Let C = 100 + 0.85YDp) represent a consumption function depending on a notion of permanent income YDp) based on some undefined combination of disposable income lagged over the past six years. In this case, the long-run marginal propensity to consume would be

A) 0.85.
B) approximately equal to 0.85 but increased slightly by the lagged structure of permanent income.
C) approximately equal to 0.85 but reduced slightly by the lag structure of permanent income.
D) approximately equal to the lag coefficient of this year's disposable income in the definition of permanent income times 0.85 but reduced slightly by the rest of the lag structure of permanent income.
E) none of the above.

Question 33

Short-run marginal propensities to consume are smaller than long-run propensities in part because

A) people need time to decide whether or not an increase in income is permanent or temporary and the propensity applied to a permanent change is smaller than the propensity applied to a temporary change.
B) people need time to decide whether or not an increase in income is permanent or temporary and the propensity applied to a permanent change is larger than the propensity applied to a temporary one.
C) people make rash decisions in the short run and thereby overspend.
D) it takes a long time for the consumer durables that dominate long- run consumption to be delivered and paid for.
E) none of the above.

Question 34

Suppose that people looked upon a $1,000 windfall as 50 percent permanent and 50 percent temporary. The short-run marginal propensity to consume out of that $1,000

A) would be 50 percent because the entire permanent component would be spent in the year it was received.
B) would be slightly higher than 50 percent because all the permanent component and a small part of the temporary component would be spent in the year it was received.
C) would be significantly greater than 50 percent because people always spend at least 50 percent of even a temporary increase and all of a permanent increase.
D) would be approximately 0.91 because that is the estimated "Keynesian" marginal propensity to consume.
E) none of the above.

Question 35

Which of the following circumstances is likely to exaggerate the expected shift in an IS curve in response to a reduction in taxes?

A) A perception that the tax change is temporary
B) A perception that the tax change is permanent
C) A prior anticipation of higher taxes throughout the foreseeable future
D) A prior anticipation that taxes would not change in the foreseeable future
E) The certain knowledge that nothing is certain but death and taxes

Question 36

Let the consumption function be defined by C = 0.85 + 0.8YDP with permanent disposable income specified according to YDP = 0.75YD + 0.25YD-1). Which of the following is true?

A) The long-run MPC = 0.85 while the short-run MPC = 0.6.
B) The long-run MPC = 0.8 while the short-run MPC = 0.75.
C) The long-run MPC = 0.8 while the short-run MPC = 0.6.
D) The long-run MPC = 0.8 while the short-run MPC lies somewhere between 0.25 and 0.75.
E) Both the long-run MPC and the short-run MPC equal 0.8.

Question 37

Aggregate response to two significant, but temporary, tax adjustments made in the United States during the late 1960s and early 1970s suggests a marginal propensity to consume for temporary changes in income

A) larger than the "Keynesian" long-run estimate of 0.94.
B) so far below the "Keynesian" long-run estimate of 0.94 that the forward- looking theoretical prediction of 0.05 to 0.1 is validated.
C) below the "Keynesian" estimate of 0.94 but above the theoretical predictions of 0.05 to 0.1.
D) that validates the applicability of the "Keynesian" long-run estimate of 0.94 for analyses of short-run phenomena.
E) identical to the forward-looking theoretical prediction of 0.16.

Question 38

Suppose a permanent increase in disposable income were received by individuals with 25 years of working lifetime ahead of them before 10 years of retirement. If they expected positive real interest rates to prevail over the foreseeable future, then forward-looking consumption theory would predict a marginal propensity to consume of

A) something less than 0.6 depending on expected real rates of interest.
B) exactly 0.6 regardless of the real rates of interest.
C) something over 0.6 but invariant to the real rates of interest.
D) something over 0.6 depending on the real rate of interest.
E) something over the "Keynesian" estimate of 0.91, but unspecified because of insufficient information.

Question 39

Which of the following have been advanced to explain why estimates of the marginal propensity to consume out of temporary increments in income are too high relative to what the theory predicts?

A) People overspend temporary windfalls because they do not believe that they are temporary.
B) People contract their consumption too far because they are liquidity constrained by their inability to borrow against their expected return to normal income levels.
C) People discount the future significantly when they make their intertemporal consumption decisions.
D) a and b only.
E) a, b, and c.

Question 40

Ando and Modigliani postulated a consumption function depending on not only disposable income but also the value of assets in which people keep their wealth. The estimated coefficient for asset value

A) emerged in the neighborhood of 0.06, pretty close to the marginal propensity to consume that the theory might predict for temporary changes in income.
B) emerged in the neighborhood of 0.7, a little low for the propensity to consume that the theory would predict for permanent changes in income.
C) emerged as expected on the basis of theory in the 0.05 range, but the estimated marginal propensity to consume out of income was a bit low, in the 0.7 range.
D) a and c.
E) none of the above.

Question 41

An intertemporal budget constraint allows families to

A) enjoy greater financial flexibility over the course of several years than in any single year.
B) consume more over their lifetime than they receive in disposable income.
C) ignore the usual constraint of living within one's lifetime income.
D) enjoy greater financial flexibility in any single year than over the course of several years.
E) ignores the effect of asset accumulation resulting from saving over time.

Question 42

Let the consumption function be given by C = 80 + 0.9YDP with permanent disposable income specified according to YDP = 0.5YD + 0.3YD-1) + 0.2YD-2). Two years after a permanent increase in income of $1,000, consumption will have increased by

A) $1,000.
B) $900.
C) $800.
D) $720.
E) $80.

Question 43

In an economy with autonomous income taxes, an increase in the marginal propensity to consume is most accurately thought of as

A) a leftward shift of the IS curve.
B) an increase in the interest sensitivity of the goods market.
C) a decrease in the interest sensitivity of the goods market.
D) both a and c.
E) both a and b.

Question 44

An increase in the marginal propensity to consume is most accurately thought of as

A) a rightward shift of the IS curve.
B) an increase in the interest sensitivity of the goods market.
C) a decrease in the interest sensitivity of the goods market.
D) both a and c.
E) both a and b.

Question 45

Let the consumption function be given by C = 0.85 + 0.8YDP with permanent disposable income specified according to YDP = 0.75YD +
0)25YD-1). Let there be a permanent $1,000 increase in income. Two years later, consumption will have increased by

A) $1,000.
B) $850.
C) $800.
D) Something between $600 and $800.
E) $600.

Question 46

Suppose the population were convinced that all current adjustments in income were temporary. In the short run then,

A) the IS curve would be steeper than usual, the government spending multiplier would be larger, and monetary policy would be weaker.
B) the IS curve would be steeper than usual, the gove rnment spending mu l t i- plier would be smaller, and monetary policy would be less effe c t ive.
C) the IS curve would be flatter than usual, the government spending multi- plier would be smaller, and monetary policy would be more effective.
D) the IS curve would be flatter than usual, the government spending multi- plier would be unaffected, but monetary policy would be less effective.
E) none of the above.

Question 47

In 1968, the Johnson administration passed a temporary surcharge on the personal income tax. Which of the following most closely describes the public's response?

A) Consumers significantly increased consumption by drawing down their savings.
B) Consumers significantly decreased consumption and began saving even more.
C) Consumers only minimally increased consumption while saving less.
D) Consumers decreased savings while maintaining the similar consumption levels.
E) Consumers significantly decreased both savings and consumption.

Question 48

Empirical tests of the forward-looking model of consumption behavior

A) confirm all its implications with household level data.
B) fail miserably with aggregate data, since aggregation obscures the behavior of individual decision-making units.
C) show evidence that liquidity constraints cause some households' consumption to be insensitive to temporary income changes.
D) show evidence that liquidity constraints cause some households' consumption to be overly sensitive to income changes in the short run.
E) none of the above.

Question 49

Which of the following functions might be an appropriate representation of a consumption function that reflects the implications of the forward-looking theory of consumption? In each, C represents consumption, Y represents income, and R represents the interest rate expressed in terms of a decimal fraction.

A) C = 230 + 0.71Y + 1,000R.
B) C = 420 + 1.3Y - 1,000R.
C) C = 276 - 1.3Y - 1,000R.
D) C = 350 + 0.65Y - 1,500R.
E) C = 220 - 0.73Y + 1,500R.

Question 50

In the event consumers expected a tax cut in the future, forward-looking consumption behavior on their part would bring about

A) a leftward shift of the IS curve as they anticipated higher future budget deficits.
B) a leftward shift of the IS curve in response to an expected decrease in government future benefits.
C) a rightward shift of the IS curve since they perceive their lifetime disposable income to have increased.
D) a rightward shift of the IS curve in response to an expected decrease in government future benefits.
E) a leftward shift of the IS curve since they perceive their lifetime disposable income to have increased.

Question 51

When Ando and Modigliani set forth a consumption function depending on disposable income and the value of assets, they expected the coefficient for assets

A) to be negative and large in magnitude compared with the coefficient for income, an estimate of the short-run marginal propensity to consume.
B) to approximate the real interest rate, an estimate of the annual consumption that can be supported by interest earnings on a piece of financial capital.
C) to be a reasonably close estimate of the long-run marginal propensity to consume, because assets holdings are dominated by the long-term portions of investment portfolios.
D) b and c only.
E) none of the above.

Question 52

As consumption becomes more sensitive to the real rate of interest,

A) the IS curve gets steeper and monetary policy grows more effective in manipulating GDP in the short run.
B) the IS curve gets flatter and monetary policy grows more effective in manipulating GDP in the long run.
C) the IS curve gets flatter and monetary policy grows more effective in manipulating GDP in the short run.
D) the IS curve is unaffe c t e d, but monetary policy grows we a ker nonetheless.
E) the IS curve gets steeper and monetary policy grows less effective in manipulating GDP in the long run.

Question 53

Let the consumption function be given by C = 80 + 0.9YDP with permanent disposable income specified according to YDP = 0.5YD + 0.3YD-1) + 0.2YD-2). Which of the following is true?

A) The long-run MPC = 0.45 while the short-run MPC = 0.9.
B) The long-run MPC = 0.9 while the short-run MPC = 0.45.
C) The long-run MPC = 1.0 while the short-run MPC = 0.9.
D) The long-run MPC = 0.9 while the sum of the short-run MPCs equals 1.0.
E) Both the long-run MPC and the short-run MPC equal 0.9.

Question 54

Suppose that the real interest rate climbs. In that case,

A) the income effect pushes consumption in the first year up in opposition to the substitution effect that pushes down first-year consumption.
B) the income effect pushes consumption up in the second year and is supported by a second push generated in year 2 by the substitution effect.
C) it would be impossible to tell whether consumption increases or decreases in year 1 because the income and substitution effects push in opposite directions.
D) the substitution effect tends to depress current consumption because future consumption becomes less expensive.
E) all of the above.

Question 55

Empirical evidence has suggested that saving in the United States is

A) extremely sensitive to changes in the real rate of interest because the income effect on consumption of those changes is negligible.
B) extremely insensitive to changes in the real interest rate because the income effect on consumption of those changes dominates the substitution effect.
C) extremely insensitive to changes in the real interest rate because the substitution effect on consumption of those changes dominates the income effect.
D) extremely sensitive to changes in the real interest rate because the substitution effect of those changes on consumption is negligible.
E) none of the above.

Question 56

The impact of an increase in the real interest rate on consumption

A) is difficult to measure since interest rates and income are moving simultaneously during the course of the business cycle.
B) tend to make consumers defer consumption due to the substitution effect.
C) tend to increase total consumption of individuals with positive wealth due to the income effect.
D) tend to decrease total consumption of individuals with negative wealth due to the income effect.
E) all of the above.

Question 57

Let there be a flat 20 percent income tax. Let the consumption function for an economy be given by C = 160 + 0.8YDP with permanent disposable income specified by YDP = 0.6YD + 0.4YD-1). If investment equals 200 and government spending amounts to 300, then what level of GDP would be equilibrium one year after GDP reached $1,500?

A) $1,450
B) $1,500
C) $1,530
D) $1,580
E) More than $1,600

Question 58

Early in the 1980s, nominal interest rates on mortgages hovered in the 13 percent range even while inflation fell to the 5 percent range. Given the expectation that the Fed would keep inflation at 5 percent, a reasonable estimate of the real rate of interest would be

A) 4 percent.
B) 5 percent.
C) 8 percent.
D) 13 percent.
E) 18 percent.