Deck 4: Consumption, saving, and Investment

Question 1

With a nominal interest rate of 8%,an expected inflation rate of 3%,and interest income taxed at a 25% rate,what is the expected after-tax real interest rate?

A)5%
B)3.75%
C)3%
D)1%

Answer 1

3%

Question 2

An increase in expected real interest rates would probably cause desired national saving to rise because

A)less must be saved to reach a given saving target.
B)the increased return makes saving more attractive.
C)the government would respond by increasing expenditures.
D)current interest rates would fall in response to higher expected real interest rates in the future.

Answer 2

the increased return makes saving more attractive.

Question 3

An increase in housing prices in Canada will likely have stronger effect on the aggregate consumption than a similar increase in the stock prices,because

A)there are more Canadian stockholders than Canadian homeowners.
B)stock prices are far more volatile than the housing prices.
C)changes in stock prices are seen as permanent changes in wealth.
D)housing prices are more volatile than the stock prices.

Answer 3

stock prices are far more volatile than the housing prices.

Question 4

If the aggregate consumption function is C = 20 + 0.75 Y,the aggregate saving function will be

A)S = 20 - 0.75 Y.
B)S = 20 + 0.75 Y.
C)S = -20 + 0.75 Y.
D)S = -20 + 0.25 Y.

Question 5

The effect of an increase in current consumption that results when a higher real interest rate makes a consumer richer is called

A)the substitution effect of the real interest rate on saving.
B)the income effect of the real interest rate on saving.
C)the net effect of the real interest rate on saving.
D)the substitution effect of the real interest rate on consumption.

Question 6

The Canadian consumption function is given by C = 50 + 0.75 Y.This implies that

A)Canadians spend 75 percent of their income on average.
B)Each Canadian spends 75 percent of her/his income.
C)Canadians on average spend 75 cents out of each additional dollar earned.
D)Canadians spend 50 dollars of their income on average.

Question 7

Three factors that cause interest rates among different financial instruments to vary are

A)default risk,expected inflation,and taxability.
B)default risk,current inflation,and taxability.
C)default risk,maturity,and taxability.
D)default risk,expected inflation,and maturity.

Question 8

Franco the economist uses data for Canada to estimate a Keynesian consumption function:
Cᵈ₌ ₀.₄₆ ₊ ₀.₉₂Y
In this equation,what is the marginal propensity to consume?

A)0.46
B)0.50
C)0.92
D)1.38

Question 9

When a person gets an increase in current income,what is likely to happen to consumption and saving?

A)Consumption increases and saving increases.
B)Consumption increases and saving decreases.
C)Consumption decreases and saving increases.
D)Consumption decreases and saving decreases.

Question 10

Aunt Agatha has just left her nephew $5000.The most likely response is for her nephew to

A)increase current consumption,but not future consumption.
B)decrease current consumption,but increase future consumption.
C)increase future consumption,but not current consumption.
D)increase both current consumption and future consumption.

Question 11

Desired national saving would unambiguously increase if there were

A)an increase in current output and expected future output.
B)an increase in expected future output and government purchases.
C)an increase in expected future output and the expected real interest rate.
D)a fall in both government purchases and expected future output.

Question 12

The housing price in Canada nearly doubled in the period 1995-2006.This implies that

A)Canadian homeowners' income has increased,leading to more consumption.
B)Canadian homeowners' wealth has increased,leading to more consumption.
C)Canadian homeowners' wealth has decreased,leading to lower consumption.
D)Canadian homeowners' income has decreased,leading to less consumption.

Question 13

An increase in expected future output while holding today's output constant would

A)increase today's desired consumption and increase desired national saving.
B)increase today's desired consumption and decrease desired national saving.
C)decrease today's desired consumption and increase desired national saving.
D)decrease today's desired consumption and decrease desired national saving.

Question 14

If you lend money to the government by buying a one-year Treasury bill,your interest rate is 4%,but if you lend money to XYZ Corporation by buying a one-year XYZ bond,you can earn 7%.What is the main reason for this difference in interest rates?

A)higher tax rate on the XYZ bond
B)higher inflation on the XYZ bond
C)higher default risk on the XYZ bond
D)higher expected real after-tax rate of return on the XYZ bond

Question 15

The effect of changes in wealth on consumers' spending is

A)significantly higher if the change in wealth arises from the housing market rather than the stock market.
B)significantly lower if the change in wealth arises from the housing market rather than the stock market.
C)significantly higher if the change in wealth arises from saving rather than from the housing market.
D)not dependent on the type of wealth.

Question 16

The nominal interest rate is 10%,the expected inflation rate is 5%,and the combined state-federal tax is 35%.The expected real after-tax rate of return is

A)1.50%.
B)3.25%.
C)5.00%.
D)6.50%.

Question 17

When a person receives an increase in wealth,what is likely to happen to consumption and saving?

A)Consumption increases and saving increases.
B)Consumption increases and saving decreases.
C)Consumption decreases and saving increases.
D)Consumption decreases and saving decreases.

Question 18

The tendency to reduce current consumption and increase future consumption as the real interest rate increases is called

A)the substitution effect of the real interest rate on saving.
B)the income effect of the real interest rate on saving.
C)the net effect of the real interest rate on saving.
D)the substitution effect of the real interest rate on investment.

Question 19

A temporary increase in government purchases,given the level of output,will lead to

A)a higher desired consumption and a higher desired national saving.
B)a lower desired consumption and a lower desired national saving.
C)a higher desired consumption and a lower desired national saving.
D)a lower desired consumption and a higher desired national saving.

Question 20

The stock market just crashed;the Dow Jones Industrial Average fell by 750 points.You would expect the effect on aggregate consumption to be the largest if which of the following facts were true?

A)The crash had been preceded by a large run-up in the price of stocks.
B)Most stocks were owned by insurance companies.
C)Most stocks were owned by pension funds that invested in the market.
D)Many individuals had invested in the stock market immediately prior to the crash.

Question 21

If the government cuts taxes today,issuing debt today and repaying the debt plus interest next year,a rational taxpayer will

A)spend the full amount of the tax cut today and reduce consumption next year.
B)increase consumption today,before taxes go up next year.
C)increase saving today,leaving consumption unchanged.
D)leave a smaller gross bequest to her or his heirs.

Question 22

The Ricardian equivalence proposition suggests that a government deficit caused by a tax cut

A)causes inflation.
B)causes a current account deficit.
C)raises interest rates.
D)doesn't affect consumption.

Question 23

A decrease in the real interest rate will

A)increase the desired capital stock.
B)decrease the desired capital stock.
C)have no effect on the desired capital stock.
D)have the same effect on the desired capital stock as an increase in corporate taxes.

Question 24

Suppose your company is in equilibrium,with its capital stock at its desired level.A permanent decline in the real interest rate now has what effect on your desired capital stock?

A)raises it,because the future marginal productivity of capital is higher
B)lowers it,because the future marginal productivity of capital is lower
C)raises it,because the user cost of capital is now lower
D)lowers it,because the user cost of capital is now higher

Question 25

Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a 25% rate,machine B costs $10,000 and depreciates at a 20% rate,machine C costs $20,000 and depreciates at a 10% rate,and machine D costs $17,000 and depreciates at an 11% rate.The expected real interest rate is 5%.

A)machine A
B)machine B
C)machine C
D)machine D

Question 26

The lesson to be learned from the Ricardian equivalence proposition is that

A)only government budget deficits generated by tax changes affect the macroeconomy.
B)government budget deficits do not affect the macroeconomy.
C)it is impossible for the government to actually reduce taxes.
D)the basic measure of the cost of government is the real resources that the government uses.

Question 27

A technological improvement will

A)increase the desired capital stock.
B)decrease the desired capital stock.
C)have no effect on the desired capital stock.
D)have the same effect on the desired capital stock as an increase in corporate taxes.

Question 28

The "q theory of investment," or "Tobin's q," states that

A)a rise in the stock market would lead firms to increase their rate of capital investment.
B)a fall in the stock market would lead firms to increase their rate of capital investment.
C)a rise in the stock market would lead firms to decrease their rate of capital investment.
D)there is no relationship between the stock price changes and the capital investment.

Question 29

When firms carry out new investment,the user cost of capital

A)increases as the amount of capital increases.
B)decreases as the amount of capital increases.
C)first decreases,then increases as the amount of capital increases.
D)remains constant as the amount of capital increases.

Question 30

You are trying to figure out how much capacity to add to your factory.You will increase capacity as long as

A)the expected marginal product of capital is positive.
B)the expected marginal product of capital is greater than or equal to the marginal product of capital.
C)the expected marginal product of capital is greater than or equal to the expected marginal product of labour.
D)the expected marginal product of capital is greater than or equal to the user cost of capital.

Question 31

The user cost of capital is given by the following formula,where PK is the real price of capital goods,d is the depreciation rate,and r is the expected real interest rate.

A)uc = (r + d)/PK
B)uc = PK/(r + d)
C)uc = dPK/r
D)uc = (r + d)PK

Question 32

The Ricardian equivalence proposition says that

A)a budget deficit caused entirely by a current tax cut has no effect on the economy.
B)a budget deficit caused entirely by an increase in government purchases has no effect on the economy.
C)any budget deficit generated by the government has no effect on the economy.
D)an increase in government spending accompanied by an equivalent increase in taxes has no effect on the economy.

Question 33

Suppose your company is in equilibrium,with its capital stock at its desired level.A permanent increase in the depreciation rate now has what effect on your desired capital stock?

A)raises it,because the future marginal productivity of capital is higher
B)lowers it,because the future marginal productivity of capital is lower
C)raises it,because the user cost of capital is now lower
D)lowers it,because the user cost of capital is now higher

Question 34

You have just purchased a new VCR to show videos to your customers.The VCR cost $500,and you depreciate the machine at a rate of 25% each year.You can borrow money from the bank at 10%,or receive 6% for depositing money at the bank.The expected inflation rate in the coming year is 5%.You used the company's own funds to purchase the VCR.The firm's user cost of capital for the first year is

A)$130.
B)$150.
C)$155.
D)$175.

Question 35

Which of the factors listed below might cause the Ricardian equivalence proposition to be violated?

A)There may be international capital inflow and outflows.
B)Consumers may not understand that increased government borrowing today is likely to lead to higher future taxes.
C)There may be constraints on the level of government spending.
D)There may be constraints on the level of government taxation.

Question 36

You have just purchased a new VCR to show videos to your customers.The VCR cost $500,and you depreciate the machine at a rate of 25% each year.You can borrow money from the bank at 10%,or receive 6% for depositing money at the bank.The expected inflation rate in the coming year is 5%.You borrowed money from the bank to purchase the VCR.The firm's user cost of capital for the first year is

A)$130.
B)$150.
C)$155.
D)$175.

Question 37

According to Tobin's q,

A)when the stock market is high,firms do not change their investment.
B)when the stock market is low,firms increase their investment.
C)when the stock market is high,firms increase their investment.
D)firms' decisions on investment do not depend on the stock market.

Question 38

A temporary increase in government purchases,when total output is held constant,would

A)reduce desired consumption but would increase desired national saving.
B)increase desired consumption but would reduce desired national saving.
C)increase both desired consumption and desired national saving.
D)reduce both desired consumption and desired national saving.

Question 39

Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a 25% rate,machine B costs $10,000 and depreciates at a 20% rate,machine C costs $10,000 and depreciates at a 10% rate,and machine D costs $17,000 and depreciates at an 11% rate.The expected real interest rate is 0%.

A)machine A
B)machine B
C)machine C
D)machine D

Question 40

Calculate the user cost of capital of a machine that costs $5,000 and depreciates at a 25% rate,when the interest rate is 5%.

A)$150
B)$500
C)$1500
D)$5000

Question 41

An economy has full-employment output of 5000.Government purchases are 1000.Desired consumption and desired investment are given by
Cᵈ = 3000 - 2000r + .10Y
Iᵈ = 1000 - 4000r
Where Y is output and r is the real interest rate.The real interest rate that clears the goods market is equal to

A)1.25%.
B)2.50%.
C)8.33%.
D)25.00%.

Question 42

An increase in the expected real interest rate tends to

A)raise desired savings only.
B)raise desired investment only.
C)raise both desired savings and desired investment.
D)raise desired savings,but lower desired investment.

Question 43

An economy has government purchases of 1000.Desired national saving and desired investment are given by
Sᵈ = 200 + 5000r + .10Y - .20G
Iᵈ = 1000 - 4000r
When the full-employment level of output equals 5000,then the real interest rate that clears the goods market will be

A)1.11%.
B)5.56%.
C)16.67%.
D)21.11%.

Question 44

A temporary increase in government purchases would cause

A)a leftward shift in the saving curve and a leftward shift in the investment curve.
B)a leftward shift in the saving curve and a rightward shift in the investment curve.
C)a leftward shift in the saving curve,but no shift in the investment curve.
D)no shift in the saving curve,but a rightward shift in the investment curve.

Question 45

The saving-investment diagram shows that a higher real interest rate due to a leftward shift of the saving curve

A)raises the profitability of investment for firms.
B)causes the amount of firms' investment to increase.
C)increases the total amount of saving because of the increase in the real interest rate.
D)causes the total amounts of saving and investment to fall.

Question 46

Any change in the economy that raises desired national saving for a given value of the real interest rate will shift the desired national saving curve

A)to the right and increase the real interest rate.
B)to the right and decrease the real interest rate.
C)to the left and increase the real interest rate.
D)to the left and decrease the real interest rate.

Question 47

What key change in 1975-87 led to a faster growth rate of equipment relative to structures?

A)a change in relative tax rates
B)a change in relative depreciation rates
C)a change in relative prices
D)a change in relative marginal productivity

Question 48

In 2001 your firm's capital stock equaled $10 million,and in 2002 it equaled $15 million.The average depreciation rate on your capital stock is 20%.Gross investment in 2002 equaled

A)$3 million.
B)$4 million.
C)$5 million.
D)$7 million.

Question 49

An economy has government purchases of 2000.Desired national saving and desired investment are given by
Sᵈ = 200 + 5000r + 0.10 Y - 20G
Iᵈ = 1000 - 4000r
When the full-employment level of output equals 5000,then the real interest rate that clears the goods market will be

A)7.78%.
B)10.00%.
C)14.44%.
D)23.33%.

Question 50

What is the difference between gross investment and net investment?

A)net investment = gross investment minus taxes
B)net investment = gross investment minus net factor payments
C)net investment = gross investment minus inventory accumulation
D)net investment = gross investment minus depreciation

Question 51

Calculate the after-tax user cost of capital of a machine that costs $5000 and depreciates at a 25% rate,when the interest rate is 5% and the tax rate on revenue is 25%.

A)$200
B)$275
C)$2000
D)$2750

Question 52

A higher real interest rate will

A)increase the profitability of new investment.
B)decrease lending of funds from firms to other economic agents.
C)reduce the desired investment of all firms.
D)reduce the desired investment of only those firms that have to borrow.

Question 53

In 2001 your firm's capital stock equaled $10 million,and in 2002 it equaled $15 million.The average depreciation rate on your capital stock is 20%.Net investment in 2002 equaled

A)$3 million.
B)$4 million.
C)$5 million.
D)$7 million.

Question 54

All else equal,a decrease in effective tax rate will lead to

A)a fall in the desired investment.
B)an increase in the interest rate.
C)an increase in the desired investment.
D)an increase in inventory.

Question 55

All else equal,a decrease in the expected future MPK will lead to

A)an increase in the desired investment.
B)no change in the desired investment.
C)a fall in the desired investment.
D)an increase in the desired level of capital.

Question 56

When desired national saving equals desired national investment,what market is in equilibrium?

A)the goods market
B)the money market
C)the foreign exchange market
D)the stock market

Question 57

You have just purchased a home that cost $250 thousand.The nominal mortgage interest rate is 8% per annum,mortgage interest payments are tax deductible,and you are in a 30% tax bracket.The expected inflation rate is 4%.Maintenance and other expenses are 8% of the initial value of the house.What is the real user cost of your house?

A)$20 thousand
B)$24 thousand
C)$27 thousand
D)$30 thousand

Question 58

The effective tax rate is

A)a single measure of tax owed by a firm.
B)a single measure of the tax credit on investment.
C)a single measure of how much tax a firm pays.
D)a single measure of the tax burden on capital.

Question 59

Your firm has capital stock of $15 million and a depreciation rate of 10%.Gross investment is $2.5 million.How much is net investment?

A)$13.5 million
B)$2.5 million
C)$1.5 million
D)$1.0 million

Question 60

Suppose your company is in equilibrium,with its capital stock at its desired level.A permanent increase in the tax rate on your firm's revenues now has what effect on your desired capital stock?

A)raises it,because the future marginal productivity of capital is higher
B)lowers it,because the future marginal productivity of capital is lower
C)raises it,because the after-tax user cost of capital is now lower
D)lowers it,because the after-tax user cost of capital is now higher

Question 61

When tax rate increases,we expect the investors

A)to require a higher before-tax future marginal product of capital in order to increase investment.
B)to require a lower before-tax future marginal product of capital in order to increase investment.
C)to increase the desired stock of capital.
D)to increase their investment.

Question 62

The Ricardian equivalence proposition is NOT supported by evidence,because

A)consumers may respond to the current tax cut by increasing their desired consumption.
B)consumers may increase their saving to respond to future tax increase.
C)consumers do not change their consumption because they expect an increase in future tax rates.
D)a cut in current tax does not affect the ultimate tax burden borne by consumers.

Question 63

An invention that raises the future marginal product of capital would cause an increase in desired investment,which would cause the investment curve to shift to the ________ and would cause the real interest rate to ________.

A)right;increase
B)right;decrease
C)left;increase
D)left;decrease

Question 64

A temporary decrease in government purchases would cause

A)an increase in the real interest rate and a decrease in desired investment.
B)a decrease in the real interest rate and an increase in desired investment.
C)a decrease in the real interest rate and an uncertain effect on desired investment.
D)an uncertain effect on the real interest rate and an increase in the level of desired investment.

Question 65

The target overnight rate is

A)the rate that chartered banks and trust companies charge on loans to their best customers.
B)the interest rate at which chartered banks make short-term loans to one another.
C)the interest rate paid on long-term bonds.
D)the interest rate central bank charges to the chartered banks.

Question 66

If consumers foresee future taxes completely,a reduction in taxes this year that is accompanied by an offsetting increase in future taxes would cause

A)an increase in the real interest rate and a decrease in desired investment.
B)a decrease in the real interest rate and an increase in desired investment.
C)a decrease in the real interest rate and an uncertain effect on desired investment.
D)a change in neither the real interest rate nor desired investment.

Question 67

John deposits $10,000 he earned from his summer job in a savings account.The interest rate is now 1 percent,the tax rate on his interest income is 5 percent,and he expects prices to rise by 2 percent.What will be his interest income after one year?

A)105
B)115
C)-105
D)-95

Question 68

Suppose the interest rate is 2 percent,the capital depreciation rate is 5 percent,and the price of a new capital is $100.What is the user cost of capital?

A)$5
B)$2
C)$3
D)$7

Question 69

A higher interest rate will lead consumers to

A)increase current consumption because their income will rise.
B)increase current consumption because their wealth will increase.
C)decrease current consumption because their savings will increase.
D)decrease current consumption because their future income will increase.

Question 70

The main reason that a theory cannot predict the effect of an increase in the real interest rate on national saving is

A)for borrowers,the substitution and income effects operate in the same direction,but for lenders they operate in the opposite direction.
B)for lenders,the substitution and income effects operate in the same direction,but for borrowers they operate in the opposite direction.
C)for lenders and borrowers,the substitution and income effects operate in the opposite direction.
D)for lenders and borrowers,the substitution and income effects operate in the same direction.

Question 71

Most people would prefer

A)higher current consumption relative to future consumption.
B)higher future consumption relative to current consumption.
C)to smooth consumption over their lifetime.
D)to match current consumption to current income.

Question 72

The after-tax real interest rate

A)can only be positive.
B)increases with expected inflation rates.
C)decreases with nominal interest rate.
D)can be negative.

Question 73

A decline in consumer confidence will lead to

A)an upward shift in the consumption function and higher current consumption.
B)a downward shift in the consumption function and lower current consumption.
C)a downward shift in the saving function and lower current saving.
D)a downward shift in the saving function and a higher interest rate.

Question 74

Suppose the real interest rate has declined.We expect that Tobin's q will

A)increase because of higher savings.
B)decrease because of higher stock prices.
C)increase because of higher stock prices.
D)decrease because of higher expected profits.

Question 75

A lump-sum increase in current taxes would cause interest rates to

A)fall if Ricardian equivalence held.
B)fall if Ricardian equivalence did not hold.
C)fall regardless of whether Ricardian equivalence held.
D)rise.

Question 76

Which of the following is true about the interest rate and saving?

A)For a saver,the income and substitution effects of an increase in interest rate work in the same directions.
B)For a borrower,the income and substitution effects of an increase in interest rate work in the same directions.
C)For a saver,the income effect of an increase in the interest rate is negative,but the substitution effect is positive.
D)For a borrower,the income and substitution effects of an increase in interest rate work in the opposite directions.

Question 77

A temporary supply shock,such as a drought,would

A)increase the marginal product of capital and increase desired investment.
B)decrease the marginal product of capital and decrease desired investment.
C)have little or no effect on desired investment.
D)decrease both the marginal product of capital and the marginal product of labour in the long-term future.

Question 78

A temporary increase in government purchases of goods and services

A)increases desired investment.
B)increases desired consumption.
C)decreases desired consumption.
D)increases desired saving.

Question 79

If consumers foresee future taxes completely,a reduction in taxes this year that is accompanied by an offsetting increase in future taxes would cause

A)a rightward shift in the saving curve and a rightward shift in the investment curve.
B)a shift in neither the saving nor the investment curve.
C)a leftward shift in the saving curve,but no shift in the investment curve.
D)no shift in the saving curve,but a rightward shift in the investment curve.

Question 80

An increase in the real interest rate will cause

A)the expected profit of firms to rise.
B)the purchase price of capital to decrease.
C)the stock prices to rise.
D)Tobin's q to decline.