Deck 4: Consumption, Saving, and Investment

Question 1

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.

Answer 1

D

Question 2

Desired national saving would decrease unambiguously if there were

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

Answer 2

A

Question 3

If the substitution effect of the real interest rate on saving is larger than the income effect of the real interest rate on saving,then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving,for someone who's a lender.

A)fall; fall
B)fall; rise
C)rise; rise
D)rise; fall

Answer 3

B

Question 4

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 5

The yield curve shows

A)the yields on stocks of different maturities.
B)the interest rates on bonds of different maturities.
C)the yields on stocks with differing default risk.
D)the yields on bonds with differing default risk.

Question 6

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 was 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 7

With no inflation and a nominal interest rate (i)of .03,a person can trade off one unit of current consumption for ________ units of future consumption.

A)0.97
B)1.03
C).03
D)-.03

Question 8

The desire to have a relatively even pattern of consumption over time is known as

A)excess sensitivity.
B)the substitution effect.
C)the consumption-smoothing motive.
D)forced saving.

Question 9

If the substitution effect of the real interest rate on saving is smaller than the income effect of the real interest rate on saving,then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving,for someone who's a lender.

A)fall; fall
B)fall; rise
C)rise; rise
D)rise; fall

Question 10

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 11

With a nominal interest rate of 4%,an expected inflation rate of 1%,and interest income taxed at a rate of 25%,what is the expected after-tax real interest rate?

A)3%
B)2%
C)1%
D)0%

Question 12

Last year,Linus earned a salary of $25,000 and he spent $24,000,thus saving $1,000.At the end of the year,he received a bonus of $1,000 and he spent $500 of it,saving the other $500.What was his marginal propensity to consume?

A).96
B).50
C).04
D).02

Question 13

Desired national saving would increase unambiguously if there were

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

Question 14

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 15

If an investor has a tax rate on interest income of 25% and the inflation rate is 4%,which bond has the lowest expected after-tax real interest rate?

A)A Treasury bond paying 9%
B)A corporate bond paying 8%
C)A Treasury bond paying 7%
D)A municipal bond paying 6%

Question 16

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

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

Question 17

The fraction of additional current income that a person consumes in the current period is known as the

A)consumption-smoothing motive.
B)consumption deficit.
C)saving rate.
D)marginal propensity to consume.

Question 18

The yield curve generally slopes upward because

A)longer maturity bonds typically pay higher interest rates than shorter maturity bonds.
B)longer maturity bonds typically pay lower interest rates than shorter maturity bonds.
C)shorter maturity bonds have more default risk.
D)longer maturity bonds are not taxable.

Question 19

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 20

Desired national saving equals

A)Y - C^d - G.
B)C^d + I^d + G.
C)I^d + G.
D)Y - I^d - G.

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

Sally will earn $30,000 this year and $40,000 next year.The real interest rate is 20% between this year and next year; she can borrow or lend at this rate.She has no wealth at the start of this year and plans to finish next year having consumed everything she possibly can.She would like to consume the same amount this year as next year.The inflation rate is 0%.
(a)How much should Sally save this year? How much will Sally consume in each of the two years?
(b)How would your answers change if the real interest rate was 40%?

Question 23

Jane wants to save $1000 of current income.With an IRA,no taxes are paid on income or interest until the money is withdrawn in five years.Without an IRA,taxes must be paid whenever income or interest is received.Jane's federal/state tax bracket is 35%,and the nominal interest rate is 8%.
(a)How much money will Jane have if she puts her money in an IRA and withdraws the money in five years?
(b)How much money will Jane have if she does NOT put her money in an IRA,but rather in a regular (taxable)savings account,for five years?
(c)How much does Jane gain in five years by using an IRA rather than a regular savings account?

Question 24

The relationship between stock prices and firms' investments in physical capital is captured by what theory?

A)User-cost-of-capital theory
B)q theory
C)Yield-curve theory
D)Keynesian theory

Question 25

Suppose you divide your life into two periods-working age and retirement age.When you work,you earn labor income Y; when retired,you earn no labor income,but must live off your savings and the interest it earns.You save the amount S while working,earning interest at rate r,so you have (1 + r)S to live on when retired.Because you don't need to consume as much when retired,you want to set consumption when working twice as high as consumption when retired.
(a)Suppose you earn $1 million over your working life,and the real interest rate for retirement saving is 50%.How much will you save and how much will you consume in each part of your life?
(b)Suppose your current income went up to $2 million when working.Now what will you save and how much will you consume each period?
(c)Suppose a social security system will pay you 25% of your working income when you are retired.Now (with Y = $1 million,as in part (a)how much will you save and how much will you consume each period?
(d)Suppose the interest rate rises (starting from the situation in part (a).Will you save more or less?

Question 26

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

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

Question 27

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

A)Machine A
B)Machine B
C)Machine C
D)Machine D

Question 28

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

A)uc = (r + d)/ P_K
B)uc = P_K/(r + d)
C)uc = dP_K/r
D)uc = (r + d)P_K

Question 29

Calculate the user cost of capital of a machine that costs $100,000 and depreciates at a rate of 25%,when the nominal interest rate is 4% and the expected inflation rate is 1%.

A)$3,000
B)$25,000
C)$28,000
D)$29,000

Question 30

Suppose the one-year T-bill rate was 5% on 1/1/2007,4% on 1/1/2008,and 6% on 1/1/2009.The GDP deflator (2004 = 100)was 110 on 1/1/2007,112 on 1/1/2008,114 on 1/1/2009,and 120 on 1/1/2010.The tax rate on interest income is 30%.
(a)Calculate the after-tax nominal rate of return for 2007,2008,and 2009.
(b)If you began with $1000 on 1/1/2007 and invested in T-bills each year (paying taxes at the end of each year),how much would you have in nominal terms on 1/1/2010? How much would you have in real terms (2004 dollars)?
(c)How much was your nominal after-tax interest earned in part (b)over the three years? How much did you earn in real (2004)after-tax dollars?

Question 31

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 labor.
D)the expected marginal product of capital is greater than or equal to the user cost of capital.

Question 32

If the rate of depreciation increases,then user cost ________ and the desired capital stock ________.

A)falls; falls
B)falls; rises
C)rises; rises
D)rises; falls

Question 33

The nominal interest rate on taxable bonds is 8%,while on municipal bonds (which aren't taxable)it is 5%.The expected inflation rate is 3% and the tax rate on interest income is 40%.Calculate the expected after-tax real interest rate on both bonds.Which would be the better investment? Now suppose the actual inflation rate turned out to be 6%.Which bond was the better investment? Would your answer change if inflation had turned out to be 0%?

Question 34

When a company must consider taxes in determining investment,its desired capital stock is chosen such that

A)MPK^{f = uc(}1-t)
B)MPK^{f = uc/(}1-t)
C)MPK^{f = t} × uc
D)t × MPK^{f = uc}

Question 35

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 36

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

A)There may be international capital inflows and outflows.
B)Consumers may not understand that an increase in 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 37

In 1991 the federal government changed the withholding amounts for personal taxes.The change meant that people wouldn't have as much withheld from their paychecks.But there was no change in the tax code itself,so the amount of tax due in April 1992 was not changed.How would consumption and saving respond to this withholding change? (Note: you may assume a real interest rate of 0%.)

Question 38

Calculate the user cost of capital of a machine that costs $5,000 and depreciates at a rate of 25%,when the nominal interest rate is 10% and the expected inflation rate is 5%.

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

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 rate of 20%,machine C costs $20,000 and depreciates at a rate of 10%,and machine D costs $17,000 and depreciates at a rate of 11%.The expected real interest rate is 5%.

A)Machine A
B)Machine B
C)Machine C
D)Machine D

Question 40

Tobin's q is equal to

A)the ratio of capital's market value to its replacement cost.
B)the ratio of capital's replacement cost to its market value.
C)the expected after-tax real interest rate.
D)the stock market value of a firm

Question 41

An economy has government purchases of 1000.Desired national saving and desired investment are given by S^d = 200 + 5000r + 0.10Y - 0.20G
I^d = 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 42

An economy has full-employment output of 5000.Government purchases are 1000.Desired consumption and desired investment are given by C^{d =} 3000 - 2000r + 0.10Y
I^d = 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 43

Cummins,Hubbard,and Hassett found that investment responded to a tax change that affected the user cost of capital,with an elasticity of

A)0.
B)-0.25.
C)-0.66.
D)-1.

Question 44

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 45

When desired national saving equals desired national investment (in a closed economy),what market is in equilibrium?

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

Question 46

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 47

Draw a diagram showing the determination of a firm's optimal capital stock,showing the relationship between the user cost of capital and the future marginal product of capital.Suppose the real interest rate declines.Show what happens to the firm's optimal capital stock.What happens to the firm's desired investment?

Question 48

Calculate the tax-adjusted user cost of capital of a machine that costs $10,000 and depreciates at a rate of 10%,when the real interest rate is 3% and the tax rate on revenue is 5%.

A)$1238
B)$1300
C)$1368
D)$1800

Question 49

You have just purchased a home that cost $250,000.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)$20,000
B)$24,000
C)$27,000
D)$30,000

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

Suppose your company is in equilibrium,with its capital stock at its desired level.A permanent decline in the expected 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 52

A firm should invest more if Tobin's q

A)equals zero.
B)is less than one.
C)equals one.
D)is more than one.

Question 53

If the stock market value of a firm is $10 million and the firm owns $15 million of capital,then Tobin's q equals

A)2/3.
B)1.
C)3/2.
D)4.

Question 54

A firm's output (Y)depends on how much capital (K)it has,according to the equation: Y = 20K - K².The real interest rate is 6% per year,the depreciation rate of capital is 14% per year and the price of a unit of capital is $80,and each unit of output sells for $1.
(a)For capital levels of 0 to 6,how much is output?
(b)For capital levels from 1 to 6,calculate the marginal product of capital.
(c)How many units of capital does the firm desire?
(d)If the real interest rate was 1% per year,how many units of capital would the firm desire?

Question 55

Your firm has capital stock of $10 million and a depreciation rate of 15%.Gross investment is $3 million.How much is net investment?

A)$1.5 million
B)$2.0 million
C)$2.5 million
D)$3.5 million

Question 56

What is the q theory of investment? Who developed it? What is q,and what do different values of q imply? How is q related to the stock market value of a firm and its capital stock?

Question 57

At the start of the year,your firm's capital stock equaled $100 million,and at the end of the year it equaled $105 million.The average depreciation rate on your capital stock is 20%.Gross investment during the year equaled

A)$1 million.
B)$5 million.
C)$7 million.
D)$25 million.

Question 58

Cummins,Hubbard,and Hassett studied the effects of taxes on investment by

A)seeing if investment spending is correlated with taxes on investment.
B)examining what happened to investment when major tax reforms took place.
C)raising tax rates on certain businesses and testing their reaction.
D)raising tax rates on equipment and reducing tax rates on structures.

Question 59

A firm has current and future marginal productivity of capital given by MPK = 10,000 - 2K + N,and marginal productivity of labor given by MPN = 50 - 2N + K.The price of capital is $5,000,the real interest rate is 10%,and capital depreciates at a 15% rate.The real wage rate is $15.
(a)Calculate the user cost of capital.
(b)Find the firm's optimal amount of employment and the size of the capital stock.

Question 60

At the start of the year,your firm's capital stock equaled $10 million,and at the end of the year it equaled $15 million.The average depreciation rate on your capital stock is 20%.Net investment during the year equaled

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

Question 61

If consumers believe that next year a recession will occur (in a closed economy),then the real interest rate ________ and investment ________.

A)falls; declines
B)falls; increases
C)rises; increases
D)rises; declines

Question 62

The substitution effect of a decrease in real interest rates is to cause a consumer to

A)increase future consumption and decrease current consumption.
B)decrease future consumption and increase current consumption.
C)increase current consumption and increase saving.
D)decrease current consumption and increase saving.

Question 63

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 labor in the long-term future.

Question 64

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 65

Suppose the government provides a tax cut today that is matched by a tax increase in the future that's equal in present value to the tax cut.This causes a consumer's saving to

A)decrease.
B)increase.
C)remain unchanged.
D)increase if the person was a lender and decrease if the person was a borrower.

Question 66

David consumes 200 in the current period and 330 in the future period.The real interest rate is 10% per period.David's present value of lifetime consumption is

A)500.
B)530.
C)550.
D)563.

Question 67

Use a saving-investment diagram to explain what happens to saving,investment,and the real interest rate in each of the following scenarios in a closed economy.
(a)In an agricultural economy,great weather this year promises a bumper crop next year,leading citizens to expect higher income next year.
(b)Government regulations going into effect next year will reduce the marginal product of capital.
(c)The government increases lump-sum taxes on citizens.

Question 68

An economy has full-employment output of 5000.Government purchases are 1000.Desired consumption and desired investment are given by
C^d = 3000 - 2000r + 0.10Y
I^d = 1000 - 4000r
where Y is output and r is the expected real interest rate.
(a)Find the real interest rate that clears the goods market.Assume that output equals full-employment output.
(b)Calculate the amount of saving,investment,and consumption in equilibrium.
(c)If a shock to wealth causes desired consumption to decline by 200 (so that the new equation for desired consumption is C^d = 2800 - 2000r + 0.10Y),find the equilibrium real interest rate,saving,investment,and consumption.

Question 69

Onerous regulations on businesses that take effect next year (in a closed economy)reduce businesses' expected future marginal product of capital.As a result,the real interest rate ________ and saving ________.

A)falls; declines
B)falls; increases
C)rises; increases
D)rises; declines

Question 70

If Claudette gets a permanent increase in her income of $1000 per year,she saves an extra $200 this year and consumes an extra $800 this year.If the increase in income had been temporary instead of permanent,she would have saved ________ of the extra income.

A)More than $200
B)Less than $200
C)Exactly $200
D)None

Question 71

A temporary decrease in government purchases would cause

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

Question 72

If the stock market booms and people feel wealthier (in a closed economy),then the real interest rate ________ and investment ________.

A)falls; declines
B)falls; increases
C)rises; increases
D)rises; declines

Question 73

Rachel earns nothing during her learning period,1100 during her working period,and nothing during her retirement period.She has initial assets of 300.The real interest rate is zero.Rachel is not allowed to borrow by the banks.Whenever possible,Rachel wants to smooth consumption between periods.How much will she save during her working period?

A)400
B)550
C)700
D)950

Question 74

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 to

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

Question 75

Use a saving-investment diagram to explain what happens to saving,investment,and the real interest rate in each of the following scenarios in a closed economy.
(a)Current output rises due to a temporary productivity increase.
(b)The tax code changes so that business firms face higher tax rates on their revenue (offset by other lump-sum tax changes so there's no overall change in tax revenue).
(c)The government increases spending temporarily for a one-year project to turn mercury into gold.
(d)The average educational level rises,inducing an increase in the future marginal productivity of capital.

Question 76

An invention that raises the future marginal product of capital (in a closed economy)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 77

An increase in the expected real interest rate tends to

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

Question 78

A curve that connects all the consumption combinations that yield the same level of utility is known as

A)an isoquant.
B)a yield curve.
C)a budget line.
D)an indifference curve.

Question 79

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 80

If the government reduces the effective tax rate on capital (in a closed economy),then the real interest rate ________ and saving ________.

A)falls; declines
B)falls; increases
C)rises; increases
D)rises; declines