Deck 16: Consumption and Investment

Question 1

Household consumption as a percentage of GDP in Canada is

A) less than that in other high-income countries.
B) greater than that in low-income countries.
C) equal to that in middle-income countries.
D) about average compared to countries around the world.

Answer 1

D

Question 2

According to the permanent-income hypothesis,a permanent increase in a person's income will

A) increase consumption more than savings.
B) increase savings more than consumption.
C) be smoothed out to where the increases in consumption and savings are roughly equal.
D) have the same effect on consumption as a transitory increase in income.

Answer 2

A

Question 3

Given a decrease in the real interest rate,the substitution effect will be ________ for lenders and ________ for borrowers.

A) negative; negative
B) negative; positive
C) positive; negative
D) positive; positive

Answer 3

D

Question 4

Consumption smoothing is a consequence of the

A) increasing marginal utility of consumption.
B) constant marginal utility of consumption.
C) intertemporal budget constraint.
D) decreasing marginal utility of consumption.

Question 5

Given a decrease in the real interest rate,the income effect will be ________ for lenders and ________ for borrowers.

A) negative; negative
B) negative; positive
C) positive; negative
D) positive; positive

Question 6

According to the permanent-income hypothesis,

A) the present value of lifetime consumption equals the present value of lifetime income.
B) the income earned in a lifetime will be evenly divided between consumption and saving.
C) household consumption depends on income that households expect to receive each year, and financial markets are used to smooth consumption in response to changes in transitory income.
D) households use financial markets to transfer funds from periods when income is high to periods when income is low.

Question 7

According to the life-cycle hypothesis,

A) the present value of lifetime consumption equals the future value of lifetime income.
B) the income earned in a lifetime will be evenly divided between consumption and saving.
C) household consumption depends on income that households expect to receive each year, and financial markets are used to smooth consumption in response to changes in transitory income.
D) households use financial markets to transfer funds from periods when income is high to periods when income is low.

Question 8

The tendency for households to consume an equal amount over time is called

A) the savings-consumption constraint.
B) intertemporal consumption.
C) consumption equality.
D) consumption smoothing.

Question 9

According to the life-cycle hypothesis,

A) consumption during retirement decreases at a greater rate than disposable income.
B) consumption during working years increases at a greater rate than disposable income.
C) saving during retirement decreases at a greater rate than disposable income.
D) consumption and saving are smoothed out over a lifetime so they both change at the same rate as disposable income.

Question 10

According to the permanent-income hypothesis,a transitory increase in a person's income will

A) increase consumption more than savings.
B) increase savings more than consumption.
C) be smoothed out to where the increases in consumption and savings are roughly equal.
D) have the same effect on consumption as a permanent increase in income.

Question 11

The intertemporal budget constraint tells us that

A) the income earned in a lifetime will be evenly divided between consumption and saving.
B) the present value of lifetime consumption equals the present value of lifetime income.
C) household consumption is based on permanent income and not transitory income.
D) consumption smoothing only occurs in years when income is greater than consumption.

Question 12

In Canada,the growth rate of expenditures has been most volatile for

A) durable goods.
B) nondurable goods.
C) services.
D) The volatility has been roughly equal for all three categories of consumption expenditures.

Question 13

If a person completely smooths consumption over his lifetime,then consumption is best represented by which of the following?

A) wealth / the number of years the person expects to live
B) lifetime income / the number of years the person expects to work
C) (wealth + lifetime income) / the number of years the person expects to live
D) (wealth + lifetime income) / the number of years the person expects to work

Question 14

Economists assume that households and firms share two important characteristics.One of these characteristics is that

A) they usually smooth spending during expansions but rarely do during recessions.
B) the growth rate in spending by each always decreases during recessions.
C) they only consider the future when making decisions.
D) they are forward looking.

Question 15

Maryanne expects to work for another 30 years and expects to live another 10 years after she retires.If Maryanne completely smooths consumption over her lifetime,for every $1000 increase in disposable income,she will use ________ for consumption each year.

A) $100
B) $333
C) $667
D) $750

Question 16

According to the life-cycle hypothesis,if a person wants consumption to be constant over her lifetime,she will smooth consumption by initially ________ over her lifetime.

A) saving, then dissaving, then borrowing
B) borrowing, then saving, then dissaving
C) dissaving, then borrowing, then saving
D) saving, then borrowing, then dissaving

Question 17

Given a decrease in the real interest rate,the income effect will be ________ for lenders and ________ for borrowers.

A) negative; negative
B) ambiguous; positive
C) positive; ambiguous
D) positive; negative

Question 18

Expectations about future profitability

A) only affect the level of investment and GDP in the future.
B) only affect the level of investment in the future, but can affect the level of GDP in the present.
C) can affect the level of investment and GDP in the present.
D) only affect the level of GDP in the future, but can affect the level of investment in the present.

Question 19

Economists assume that the objective of households is to maximize ________,and that the objective of firms is to maximize ________.

A) leisure; profits
B) utility; profits
C) utility; utility
D) leisure; utility

Question 20

What do economists mean when they characterize households and firms as forward looking?

Question 21

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.Assuming taxes are zero,if Hector completely smooths consumption over his lifetime,his annual consumption is

A) $60 000.
B) $62 222.
C) $80 000.
D) $106 667.

Question 22

Households in Canada more completely smooth out expenditures on

A) durable goods and nondurable goods than on services.
B) durable goods than on nondurable goods and services.
C) nondurable goods and services than on durable goods.
D) services and durable goods; nondurable goods.

Question 23

A decrease in the real interest rate acts as ________ for lenders and as ________ for borrowers.

A) an increase in wealth; an increase in wealth
B) an increase in wealth; a decrease in wealth
C) a decrease in wealth; an increase in wealth
D) a decrease in wealth; a decrease in wealth

Question 24

Maryanne expects to work for another 30 years and expects to live another 10 years after she retires.If Maryanne completely smooths consumption over her lifetime,for every $1000 increase in wealth,she will use ________ for consumption each year.

A) $10.00
B) $25.00
C) $100
D) $333

Question 25

The real interest rate can be thought of as

A) the price of current consumption relative to future consumption.
B) the price of current consumption completely smoothed over a lifetime.
C) the price of future consumption smoothed completely over a lifetime.
D) the price of current consumption divided by the price of current saving.

Question 26

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.Assuming taxes are zero,if Hector receives a $20 000 bonus during his first year of work and he completely smooths consumption over his lifetime,his annual consumption is

A) $60 000.
B) $60 333.
C) $80 444.
D) $107 000.

Question 27

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.Yearly taxes are $20,000,and Hector received a one-time tax rebate of $5000 during his first year of work.If Hector completely smooths consumption over his lifetime,his annual consumption is

A) $37 516.67.
B) $44 916.67.
C) $45 083.33.
D) $60 111.11.

Question 28

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.Assuming taxes are zero,if Hector receives an unexpected $20 000 increase in salary his first year of work and he completely smooths consumption over his lifetime,his annual consumption is

A) $67 500.
B) $75 000.
C) $80 000.
D) $111 111.

Question 29

If the substitution effect is stronger than the income effect,an increase in real interest rates will lead to ________ in aggregate consumption and will lead to ________ in household saving.

A) an increase; a decrease
B) a decrease; a decrease
C) a decrease; an increase
D) an increase; an unclear change

Question 30

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.If yearly taxes are $20 000 and Hector completely smooths consumption over his lifetime,his annual consumption is

A) $37 500.
B) $45 000.
C) $60 000.
D) $70 000.

Question 31

Maryanne expects to work for another 30 years and expects to live another 10 years after she retires.If Maryanne completely smooths consumption over her lifetime,her marginal propensity to consume out of permanent increases in income is

A) 0.25.
B) 0.33.
C) 0.67.
D) 0.75.

Question 32

Maryanne expects to work for another 30 years and expects to live another 10 years after she retires.If Maryanne completely smooths consumption over her lifetime,her marginal propensity to consume out of wealth is

A) 0.025.
B) 0.033.
C) 0.075.
D) 0.10.

Question 33

An increase in real interest rates will ________ current consumption for households who are lenders and will ________ current consumption for households who are borrowers.

A) increase; decrease
B) decrease; increase
C) have an unclear effect on; decrease
D) decrease; have an unclear effect on

Question 34

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.If yearly taxes are $20 000 and Hector completely smooths consumption over his lifetime,Hector's annual consumption is ________ less than it would be if yearly taxes were zero.

A) $5000
B) $7500
C) $15 000
D) $20 000

Question 35

The substitution effect indicates that higher real interest rates ________ current consumption for households who are lenders and ________ current consumption for households who are borrowers.

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

Question 36

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.If Hector receives a $20 000 bonus during his first year of work and he completely smooths consumption over his lifetime,his marginal propensity to consume out of a transitory increase in income is

A) 0.004.
B) 0.017.
C) 0.075.
D) 0.75.

Question 37

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.If Hector receives an unexpected $20 000 increase in salary his first year of work and he completely smooths consumption over his lifetime,his marginal propensity to consume is

A) 0.6.
B) 0.67.
C) 0.75.
D) 0.8.

Question 38

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.If yearly taxes are $20 000 and Hector completely smooths consumption over his lifetime,Hector's average annual saving is ________ less than it would be if yearly taxes were zero.

A) $5000
B) $7500
C) $15 000
D) $20 000

Question 39

If the substitution effect is stronger than the income effect,a decrease in real interest rates will ________ current consumption for households who are lenders and will ________ current consumption for households who are borrowers.

A) increase; decrease
B) decrease; increase
C) increase; increase
D) increase; have an unclear effect on

Question 40

The income and substitution effects move in ________ for lenders and in ________ for borrowers.

A) the same direction; the same direction
B) the same direction; opposite directions
C) opposite directions; the same direction
D) opposite directions; opposite directions

Question 41

Figure 16.1

Refer to Figure 16.1.An increase in expected output in the future is best represented by a movement from

A) point A to point B.
B) point B to point A.
C) point A to point C.
D) point C to point A.

Question 42

Figure 16.1

Refer to Figure 16.1.A decrease in the depreciation rate is best represented by a movement from

A) point A to point B.
B) point B to point A.
C) point A to point C.
D) point C to point A.

Question 43

Samantha's wealth is $100 000,she expects to work for another 30 years at a constant salary of $200 000 and live for another 50 years.Assume yearly taxes are $50 000 and that Samantha completely smooths consumption over her lifetime.Calculate the following:
a. Samantha's annual consumption
b. Samantha's annual consumption if she receives a one-time tax rebate of $10 000 during her first year of work
c. The amount of the tax rebate that Samantha will save during her first year of work

Question 44

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.Yearly taxes are $20 000,and Hector received a one-time tax rebate of $5000 during his first year of work.Shortly after the tax rebate is announced,the government unexpectedly announces that the one-time tax rebate will actually become a permanent tax reduction.If Hector completely smooths consumption over his lifetime,his annual consumption will increase by ________ due to the tax rebate becoming permanent in the following year.

A) $2733.33
B) $3666.67
C) $3750.00
D) $5000.00

Question 45

A firm maximizes profits when the ________ equals the ________.

A) actual marginal product of capital; actual marginal product of labour
B) actual marginal product of capital; expected marginal product of capital
C) expected marginal product of capital; opportunity cost of capital
D) expected marginal product of capital; user cost of capital

Question 46

An increase in uncertainty about the future will tend to ________ precautionary saving and ________ the desired level of wealth for households.

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

Question 47

Explain the permanent-income hypothesis and the life-cycle hypothesis.How are these hypotheses similar?

Question 48

What is precautionary saving? What might cause precautionary saving to increase or decrease if households have a desired level of wealth?

Question 49

Samantha's wealth is $100 000,she expects to work for another 30 years at a constant salary of $200 000 and live for another 50 years.Assume taxes are zero and that Samantha completely smooths consumption over her lifetime.Calculate the following:
a. Samantha's annual consumption
b. Samantha's annual consumption if she won $50 000 in the lottery during her first year of work
c. Samantha's annual consumption if her lottery win paid $50 000 per year for 30 years

Question 50

Figure 16.1

Refer to Figure 16.1.If a firm expects that consumer preference for its product will increase in the future,this is best represented by a movement from

A) point A to point C.
B) point B to point A.
C) point A to point B.
D) point C to point A.

Question 51

Given a real interest rate,a decrease in taxes on saving ________ the after-tax real interest rate and ________ the incentive to save.

A) increases; increases
B) increases; reduces
C) decreases; increases
D) decreases; reduces

Question 52

Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.Yearly taxes are $20 000,and Hector received a one-time tax rebate of $5000 during his first year of work.If Hector completely smooths consumption over his lifetime,he will save ________ of the tax rebate during his first year of work.

A) $1250.00
B) $2666.67
C) $3750.00
D) $4916.67

Question 53

The expected real cost to a firm of using an additional unit of capital during a period of time is the

A) user cost of capital.
B) marginal product of capital.
C) marginal cost of capital.
D) opportunity cost of capital.

Question 54

John Maynard Keynes described periods of irrational pessimism and optimism that affect the investment behaviour of firms as animal spirits.When considering the investment behaviour of firms,animal spirits can be thought of as changes in the

A) actual marginal product of capital.
B) capital stock.
C) expected marginal product of capital.
D) user cost of capital.

Question 55

The president of the hypothetical country of Accordia implements a temporary two-year tax cut on income taxes.According to the permanent-income hypothesis,these tax cuts would represent ________ income and would have ________ on consumption.

A) permanent; a significant impact
B) permanent; very little impact
C) transitory; a significant impact
D) transitory; very little impact

Question 56

Figure 16.1

Refer to Figure 16.1.An increase in the real interest rate is best represented by a movement from

A) point A to point B.
B) point B to point A.
C) point A to point C.
D) point C to point A.

Question 57

The effects of tax incentive programs such as RRSP and TFSA accounts suggest that these government programs designed to increase saving lead to

A) a decrease in the private capital stock.
B) decreased labour productivity.
C) an increase in the standard of living.
D) an increase in the real interest rate.

Question 58

The effects of tax incentive programs such as RRSP and TFSA accounts suggest that these government programs designed to increase saving lead to ________ in the private capital stock.

A) virtually no change
B) a slight decrease
C) a slight increase
D) a significant increase

Question 59

Figure 16.1

Refer to Figure 16.1.A decrease in the real price of capital goods is best represented by a movement from

A) point A to point B.
B) point B to point A.
C) point A to point C.
D) point C to point A.

Question 60

The costs associated with the user cost of capital include all of the following,except

A) the real price of the capital good.
B) the expected change in the marginal cost of capital based on expectations of the future.
C) the real interest cost of borrowing to finance the purchase of the capital good.
D) the depreciation costs associated with actually using the capital good.

Question 61

The Vuvuza Corporation currently has 10 million shares of stock outstanding,the stock is trading for $42 per share,and its stock of capital goods is valued at $70 million.The Tobin's q value for the Vuvuza Corporation is

A) 0.14.
B) 1.7.
C) 6.
D) 7.

Question 62

Temporary tax breaks such as the increase in depreciation will tend to

A) increase investment expenditures because the tax breaks will entice firms to leave other countries and invest in Canada.
B) have little impact on current investment expenditures since the tax breaks are temporary.
C) increase investment expenditures in both the short run and the long run, since investment is irreversible.
D) increase investment expenditures in the short run but also increase the uncertainty and volatility of investment since the tax breaks are temporary.

Question 63

For each of the following changes,explain what will happen to the expected marginal product of capital curve or the user cost of capital curve,and what will happen to the desired capital stock:
a. The real price of capital goods increases.
b. The depreciation rate increases.
c. The corporate income tax rate decreases.
d. The real interest rate decreases.
e. Expected future output decreases.

Question 64

Suppose the government decides to decrease the amount of investment spending that firms are allowed to depreciate for tax purposes from 50% to 25%,effective next year.What effect should this change have on the desired capital stock and the level of investment spending next year? Use a graph to explain your answer.

Question 65

Assume that a temporary tax break has been put in place that allows for an increase in allowable depreciation.If and when the government changes the depreciation allowance back to its original amount,the desired capital stock will ________ and investment spending will ________.

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

Question 66

Explain why asymmetric information can cause the real interest rate to increase,and why increases in the real interest rate can actually make lending more risky for financial institutions.

Question 67

Explain how changes in corporate taxes affect the investment decisions of firms.

Question 68

Tobin's q is the ratio of the

A) dividend payments of a firm to the current stock price of the firm.
B) market value of a firm to the replacement cost of its capital.
C) current stock price of a firm to the number of outstanding shares of stock in the firm.
D) current stock price of a firm to the total earnings of the firm.

Question 69

The Vuvuza Corporation currently has 10 million shares of stock outstanding,the stock is trading for $42 per share,and its stock of capital goods is valued at $70 million.Based on the Tobin's q value for the Vuvuza Corporation,we would expect Vuvuza to

A) increase its capital stock.
B) depreciate more of its assets.
C) issue more shares of stock to be able to afford to finance investment expenditures.
D) cut back on current production.

Question 70

What is meant by the statement that investment projects are irreversible? How does the idea that investment projects are irreversible affect the volatility of investment in capital goods?

Question 71

During recessions,the value of collateral decreases and corporate profits decrease,so firms do not have cash to finance new investment projects.Therefore,credit rationing depends on the state of the economy.This situation is known as the

A) risk acceptance cost.
B) lender's dilemma.
C) default premium.
D) financial accelerator.

Question 72

Assume that a temporary tax break has been put in place that allows for an increase in allowable depreciation.If and when the government changes the depreciation allowance back to its original amount,this should cause the

A) uc curve to shift down.
B) uc curve to shift up.
C) MPKᵉ curve to shift to the right.
D) MPKᵉ curve to shift to the left.

Question 73

Credit rationing and the financial accelerator are responsible,in part,for

A) the significant volatility of gross private investment.
B) the significant volatility of real personal consumption.
C) smoothing gross private investment during severe recessions.
D) smoothing real personal consumption during expansions.

Question 74

Figure 16.1

Refer to Figure 16.1.An increase in the corporate tax rate is best represented by a movement from

A) point A to point B.
B) point B to point A.
C) point A to point C.
D) point C to point A.