Deck 15: The Economics of Consumption Behavior

Question 1

Figure 15-1
Figure above displays the consumption pattern over the lifetime of an individual. Saving and asset accumulation occur during the years ________ according to ________ theory of consumption.

A) R to L; Keynes'
B) R to L; Modigliani's
C) O to R; Friedman's
D) O to R; Modigliani's

Answer 1

O to R; Modigliani's

Question 2

Keynes's theory of consumption predicts that the aggregate saving rate

A) increases as society becomes richer.
B) falls as society becomes richer.
C) is constant in the long-run.
D) falls with higher incomes in a cross-section of income.

Answer 2

increases as society becomes richer.

Question 3

While Modigliani's LCH is similar to Friedman's PIH in several ways, it does differ in that it

A) assumes individuals base their consumption decisions on a time span greater than one year.
B) assumes that individuals prefer to maintain a stable consumption pattern.
C) attempted to reconcile the seemingly paradoxical cross-section and time-series empirical data.
D) gives an important role to assets as a determinant of consumption behavior.

Answer 3

gives an important role to assets as a determinant of consumption behavior.

Question 4

The largest component of total spending is

A) private investment, the capital consumption allowance.
B) government spending on public goods.
C) private consumption on durable and non-durable goods.
D) public consumption of non-durable goods.

Question 5

Both the PIH and the LCH predict that

A) the sum of saving and consumer durable purchases should increase in relation to personal income in booms and fall in recessions.
B) the sum of saving and consume nondurable purchases should increase in relation to personal income in booms and fall in recessions.
C) the sum of saving and consumer durable purchases should decrease in relation to personal income in booms and increase in recessions.
D) saving should increase in relation to personal income in booms and fall in recessions, but that consumer durables tend to behave in a more stable manner over a cycle.

Question 6

Which of the following is not usually assumed about the effect of disposable income on aggregate consumer spending. Which is not usually assumed?

A) consumer spending is higher levels of disposable income
B) at low levels of disposable income, saving may be negative
C) consumption is always less than disposable income
D) a rise in income leads to a less than proportionate rise in consumption

Question 7

The permanent-income hypothesis seeks primarily to explain the

A) observed long-term constancy of the saving ratio.
B) observed variation in the short-term saving ratio.
C) unimportance of transitory income changes.
D) All of the above are correct.

Question 8

The challenge for economists in the early postwar period was to develop a consumption hypothesis that could explain how

A) the saving ratio could remain fairly constant across income groups while the aggregate saving ratio increased over time as average real income grew.
B) the saving ratio for high-income families could be lower than for low-income families while the aggregate saving ratio remained fairly constant over time as average real income grew.
C) the saving ratio for high-income families could be higher than for low-income families while the aggregate saving ratio remained fairly constant over time as average real income grew.

Question 9

Both the PIH and the LCH predict that

A) total consumption may rise as a fraction of income when actual income rises due to the upsurge in purchases of consumer durables.
B) the saving ratio will fall with higher income when consumer durables are counted as consumption expenditure.
C) the saving ratio will fall with higher income when consumer durables are counted as saving.
D) A and B are both correct.

Question 10

Friedman measured "permanent" income by assuming that people adjusted their consumption on the basis of

A) an "error learning" process with respect to their expected income.
B) an adaptive expectation formation of their expected income.
C) transitory income and the level of income expected over a period of years in the future.
D) All of the above.

Question 11

The higher the marginal propensity to consume, the

A) smaller will be the simple multiplier.
B) more insulated will be consumption spending from exogenous shocks to the economy.
C) less effective will be any given monetary or fiscal policy.
D) more unstable the economy will be.

Question 12

An individual's permanent income is

A) constant over time.
B) the same as his current income.
C) unaffected by tax changes.
D) equal to his expected average income.

Question 13

The life cycle hypothesis explains the long run constancy of the savings rate and short run variability of savings rate provided

A) the proportions of working and retired people are constant in each historical era.
B) the saving behavior of each age group does not change from generation to generation.
C) A and B are both required to explain the apparent contradiction.
D) Friedman's PIH is in error.

Question 14

Of the three major categories of consumption, ________ is the most volatile because their purchase ________.

A) services; is sensitive to income levels
B) nondurables; is sensitive to income levels
C) durables; can be postponed when incomes decline
D) durables; they are necessities

Question 15

A central tenet of the position against policy activism is that

A) consumption spending is highly unstable.
B) consumption spending is highly stable.
C) aggregate policies have little effect on consumption.
D) instability in private consumption will always be offset by variations in other elements of private spending.

Question 16

The MPC on ________ income is less than the MPC on ________ income according to ________ theory.

A) transitory; permanent; Friedman's
B) transitory; permanent; Modigliani's
C) permanent; transitory; Modigliani's
D) permanent; transitory; Friedman's

Question 17

Time-series studies of consumption reveal that

A) the long-term saving ratio is rising.
B) the long-term saving ratio is falling.
C) the long-term saving ratio is constant but the marginal propensity to consume is falling.
D) both the long-term marginal propensity to save and the long-term saving ratio are constant.

Question 18

Suppose an individual were to win $1,000 in Las Vegas. The permanent-income hypothesis predicts that the individual would NOT be likely to

A) put his winnings in the bank.
B) throw a party.
C) buy a dishwasher.
D) purchase some shares in a corporation.

Question 19

The savings rate ________ over the long run but ________ over the short run.

A) is constant as Keynes assumed; varies as Friedman assumed
B) is constant as Friedman assumed; varies as Keynes assumed
C) is constant as Friedman assumed; varies as Friedman assumed
D) varies as Keynes assumed; varies as Keynes assumed

Question 20

If people leave bequests primarily because they are uncertain about the timing of their deaths,

A) the marginal propensity to consume out of a temporary change in income would tend to be higher than in the simple version of the LCH.
B) unrealized capital gains from higher housing prices will probably lead to a higher consumption-to-income ratio than in the simple version of the LCH.
C) increases in wealth from the stock market would be consumed over a longer time horizon than in the simple version of the LCH.
D) A and C are both correct.

Question 21

The fact that 80% of the assets accumulated during a lifetime are bequeathed to heirs in the United States suggests that

A) the appropriate time horizon for consumption theory is the lifetime of the earner.
B) the appropriate time horizon for consumption theory is intergenerational.
C) the Barro-Ricardo equivalence theorem is correct.
D) it is true that higher taxes increase savings.

Question 22

Which of the following purchases is most likely to rise as the result of a temporary tax cut, according to the permanent-income hypothesis?

A) television sets and other consumer durables
B) steak dinners and other consumer non-durables
C) trips to the Virgin Islands and other vacation destinations
D) theater tickets and other entertainment expenditures

Question 23

What is the main argument which explains why the data do not show a positive relation between the deficit producing tax cuts in the early eighties savings rates?

A) people will increase savings to "finance" debt repayment by future generations
B) people will increase consumption to "finance" debt repayment by future generations
C) savings is determined by uncertain events, the timing of future illnesses and death
D) savings is determined by certain events, the timing of future illnesses

Question 24

Gordon characterizes Modigliani as a prominent activist yet several implications of his life cycle hypothesis support the non-activists. One of these implications is

A) transitory increases in income associated with the business cycle are not expected to last a lifetime so current consumption is relatively stable.
B) permanent increases in income associated with the business cycle are not expected to last a lifetime so current consumption is relatively stable.
C) transitory increases in income associated with the business cycle are not expected to last a lifetime so current consumption is relatively unstable.
D) transitory increases in income associated with the business cycle are to last a lifetime so current consumption is relatively stable.

Question 25

In the life-cycle hypothesis of consumption, two individuals with the same age, tastes, family composition, and income will

A) consume the same amount.
B) each consume less the greater is their accumulated wealth.
C) each have positive saving ratios.
D) consume differing amounts if their wealth differs.

Question 26

What is the main argument which explains why an increased public deficit financed tax cut may not result in increased consumption?

A) people will increase savings to "finance" debt repayment by future generations
B) people will increase consumption to "finance" debt repayment by future generations
C) savings is determined by uncertain events, the timing of future illnesses and death
D) savings is determined by certain events, the timing of future illnesses and death

Question 27

Gordon characterizes Modigliani as a prominent activist yet several implications of his life cycle hypothesis support the non-activists. One of these implications is

A) the real asset effect would dampen and thus stabilize spending.
B) the real asset effect would dampen and thus destabilize spending.
C) the real asset effect would increase and thus stabilize spending.
D) the real asset effect would increase the size of the multiplier.

Question 28

The hypothesis that individuals base consumption on their expected long run average income is the

A) life cycle hypothesis.
B) forward looking expectation hypothesis.
C) permanent-income hypothesis.
D) None of the above.

Question 29

The hypothesis that people attempt to stabilize their consumption over their entire lifetime is the

A) life cycle hypothesis.
B) forward looking expectation hypothesis.
C) permanent-income hypothesis.
D) None of the above.

Question 30

During a recession the Keynesian consumption theory predicts that the savings rate will ________ and the ________ theory that savings rate will ________.

A) fall; PIH; fall
B) fall; LCH; fall
C) rise; PIH and LCH; fall
D) rise; PIH and LCH; rise

Question 31

A fall in the price level would lead to an increase in consumption according to ________ because ________.

A) Friedman; the value of assets fall
B) Modigliani; the value of assets fall
C) Friedman; the value of assets rise
D) Modigliani; the value of assets rise

Question 32

Figure 15-2
In the figure above, the difference between consumption levels at point A and point B is equal to

A) the long run MPC times the change in disposable income.
B) the short run MPC times the change in disposable income.
C) (Y0 - Y2) times the short run change in income.
D) the long run change in income times (Y0 - YP).

Question 33

The PIH predicts that temporary tax cuts would

A) be spent on consumer nondurables and services.
B) be offset by an increase in the saving ratio.
C) be offset by a decrease in the saving ratio.
D) be treated the same as permanent tax cuts.

Question 34

Using consumption theories based upon forward looking hypothesis, a temporary increase in government expenditures will have ________ impact on induced consumption.

A) a large multiple
B) a small multiple
C) a variable
D) no

Question 35

The consumption theories proposed by Modigliani and Friedman suggest that during recessions consumers reduce

A) consumption and maintain saving.
B) saving and maintain consumption.
C) consumption and saving.
D) consumption and investment.

Question 36

If you won the state lottery and were guaranteed a monthly income of $5000 for life then ________ would argue that your ________ income has increased.

A) Friedman; permanent
B) Friedman; transitory
C) Modigliani; transitory
D) Modigliani; permanent

Question 37

Less developed countries are often characterized by imperfect capital markets. Assuming that the LCH applies to these countries and that a large proportion of the population is below fifty the

A) MPC should be relatively high.
B) MPC should be relatively low.
C) frequency of liquidity constraints is low.
D) sensitivity of consumption to loans is low.

Question 38

Modigliani's consumption function differs from both Friedman's and Keynes' function in which of the following?

A) it is based on forward looking expectations
B) it is based on disposable income received over time
C) it is based on the value of assets accumulated over time
D) it is based on disposable income or permanent income

Question 39

The application of rational expectations to the permanent-income hypothesis implies that information contained in

A) only past income levels will determine permanent income.
B) only past income levels will determine transitory income.
C) only new changes in income that are unanticipated can change permanent income.
D) only new changes in income that are anticipated can change permanent income.

Question 40

According to Friedman, the apparent conflict between cross-section data which shows a saving rate that varies with income group and time-series data which shows that the saving ratio over the past century is fairly constant is resolved by

A) pointing out that cross-section and time-series data are not comparable.
B) interpreting the low saving of poor people as due to the fact that they must buy necessities.
C) interpreting the high saving of rich people as due to the transitory nature of much income earned by the rich.
D) distinguished between a permanent marginal propensity to consume and a transitory marginal propensity to consume.

Question 41

The LCH theory argues that

A) over time, the saving rate of low-income people tended to rise at a faster rate than that of other income groups.
B) the aggregate saving rate depended on the age distribution within the economy.
C) over time, the aggregate saving rate was relatively constant.
D) over time, the aggregate saving rate would increase.

Question 42

Suppose that medical researchers discover a new drug which slows the aging process allowing the average life span in the United States to increase to 95 years of age. The lifecycle hypothesis suggests that

A) consumption spending would increase since lifetime income increases.
B) consumption spending would increase since estimates of permanent income would increase.
C) consumption spending would decrease since savings would rise to provide income for the longer retirement periods.
D) None of the above is correct since predicted future annual incomes may not change.

Question 43

In the simple Keynesian consumption function, consumption demand is

A) a function of disposable income alone.
B) a function of disposable income and an autonomous component.
C) simply an autonomous amount exogenous to the model.
D) a function of the interest rate and an autonomous component.
E) a function of the interest rate alone.

Question 44

A lower interest rate

A) lowers the marginal propensity to consume out of permanent .B income.
B) raises the marginal propensity to consume out of permanent income.
C) lowers the proportion of actual income considered to be permanent income.
D) raises the proportion of actual income considered to be permanent income.

Question 45

The apparent conflict between the time-series and cross-section evidence on the U.S. saving ratio, where cross-section studies predict a long-run ________ in the ratio that does not emerge from the time-series studies, is ________ by the permanent-income and life-cycle hypotheses.

A) rise, resolved
B) rise, created
C) fall, resolved
D) fall, created

Question 46

Milton Friedman first proposed the hypothesis that individuals consume a fraction of their expected, or ________, income.

A) disposable
B) net
C) attainable
D) permanent
E) life-cycle

Question 47

Keynes was concerned about an implication of his consumption theory: that as an economy becomes more prosperous, its saving rate becomes too ________ to sustain that prosperity. Such a long-term trend in the U.S. saving rate is ________ in the time-series data.

A) large, found
B) large, not found
C) small, found
D) small, not found

Question 48

The permanent-income hypothesis was developed in the 1950s by economist

A) Edward Prescott.
B) James Tobin.
C) Robert Solow.
D) Milton Friedman.

Question 49

The least volatile component of current consumption expenditure is ________, and the changes in its relative importance help explain why the volatility of overall consumption has ________ since the 1950s.

A) nondurable goods, risen
B) nondurable goods, fallen
C) durable goods, stayed the same
D) durable goods, fallen
E) services, stayed the same

Question 50

In U.S. recessions, growth in total consumption is ________, which is ________ with the workings of the permanent-income and life-cycle hypotheses.

A) largely uninterrupted, perfectly consistent
B) largely uninterrupted, rather inconsistent
C) noticeably reduced, perfectly consistent
D) noticeably reduced, rather inconsistent

Question 51

The PIH and LCH theories ________ the case for activism, while the procyclical behavior of consumer spending for durable goods ________ the case for activism.

A) supports; supports
B) supports; does not support
C) do not support; does not support
D) do not support; supports

Question 52

Both the permanent-income and life-cycle hypotheses are based on the crucial assumption of ________ expectations.

A) rational
B) adaptive
C) backward-looking
D) forward-looking

Question 53

Suppose that medical researchers discover a new drug which slows the aging process, allowing the average life span in the United States to increase to 95 years of age. The permanent-income hypothesis suggests that

A) consumption spending would increase since lifetime income increases.
B) consumption spending would increase since estimates of permanent income would increase.
C) consumption spending would decrease since savings would rise to provide income for the longer retirement periods.
D) None of the above is correct since predicted future annual incomes may not change.

Question 54

The Keynesian consumption function implies that at a given moment persons with high incomes are saving ________ persons with low incomes, a prediction which is ________ by actual cross-section consumption data.

A) a lower fraction of income than, confirmed
B) a lower fraction of income than, not confirmed
C) a higher fraction of income than, confirmed
D) a higher fraction of income than, not confirmed
E) the same fraction of income as, confirmed

Question 55

The largest component of current consumption expenditure is ________, while the most volatile component is ________.

A) durable goods, nondurable goods
B) durable goods, services
C) services, durable goods
D) services, nondurable goods
E) nondurable goods, services

Question 56

Both the permanent-income and life-cycle hypotheses modify Keynesian consumption theory by distinguishing the effects of

A) temporary and permanent changes in disposable income.
B) changes in the disposable income of upper income and lower income classes.
C) changes in labor income and interest income.
D) small and large changes in disposable income.

Question 57

With a temporary income tax surcharge, according to the ________, household consumption should ________.

A) LCH; stay the same
B) PIH; stay the same
C) LCH; fall since earnings over the lifecycle will decrease
D) PIH; fall since disposable income will fall

Question 58

A person is calculating his permanent income by adaptive expectations. Last year's permanent income was 38,000, this year's actual income is 44,000, and j = 0.25. This year his permanent income is

A) 39,500.
B) 42,500.
C) 59,000.
D) 20,500

Question 59

With a temporary income tax surcharge, according to the ________, household consumption should ________.

A) LCH; stay the same since life cycles have not changed
B) LCH; rise even though disposable income falls
C) PIH; fall since disposable income falls
D) None of the above is correct since there would be no change in "permanent" income.

Question 60

With a temporary income tax surcharge, according to the ________, household consumption should ________.

A) PIH; fall as disposable income falls
B) PIH; rise since the decrease is disposable income is temporary
C) LCH; fall since disposable income over the lifecycle falls
D) None of the above is correct since a temporary change affects neither permanent income or relative lifecycle earnings.

Question 61

An individual having an unusually bad year will be on her short-run consumption function at a point ________ her long-run consumption function, with an unusually ________ saving ratio.

A) above, high
B) above, low
C) below, high
D) below, low

Question 62

An individual having an unusually good year will be on his short-run consumption function at a point ________ his long-run consumption function, with an unusually ________ saving ratio.

A) above, high
B) above, low
C) below, high
D) below, low

Question 63

Working with the life-cycle hypothesis, we find in a cross-section study of consumption that as income rises there is a growing proportion of ________ people and thus a ________ saving ratio.

A) retired, rising
B) retired, falling
C) working, rising
D) working, falling

Question 64

Replacing the simple Keynesian consumption function with the function based on the permanent-income hypothesis results in a ________ short-run multiplier, implying a ________ stable private economy.

A) higher, more
B) higher, less
C) lower, more
D) lower, less

Question 65

By the permanent-income hypothesis, the long-run marginal propensity to consume is

A) j.
B) k.
C) kj.
D) k - j.
E) k/j

Question 66

In the life-cycle hypothesis, people are assumed to have a consumption pattern that leads them to dissave

A) at no point in their life.
B) in the working years up to retirement.
C) in their retirement years.
D) in every year of their life.

Question 67

Both the permanent-income and life-cycle hypotheses make the assumption that people prefer a ________ consumption pattern in the long run, and so have a ________ short-run MPC out of sudden changes in income.

A) smooth, low
B) smooth, high
C) jagged, low
D) jagged, high

Question 68

Suppose a person calculates his permanent income by adaptive expectations. Last year's permanent income was 54,000, this year's actual income is 44,000, j = 0.20, and k = 0.82. What is his consumption expenditure this year?

A) 34,840
B) 43,472
C) 36,784
D) 42,640
E) 37,720

Question 69

Suppose a person calculates her permanent income by adaptive expectations. Last year's permanent income was 38,000, this year's actual income is 41,000, j = 0.30, and k = 0.86. What is her consumption expenditure this year?

A) 30,422
B) 12,174
C) 40,226
D) 38,774
E) 33,454

Question 70

In the life-cycle hypothesis, a person who expects to work for R years earning Y dollars per year, and live for a total of L years, will consume ________ per year.

A) RY - (L - R)Y
B) LRY
C) (L - R)Y
D) (R/L)Y

Question 71

The life-cycle hypothesis was developed in the 1950s, primarily by the economist

A) Franco Modigliani.
B) Robert Lucas.
C) Walter Rostow.
D) Nils Hellstrom.

Question 72

By the permanent-income hypothesis, the MPC of transitory income is

A) k.
B) j.
C) kj.
D) k - j.
E) 0.

Question 73

The life-cycle hypothesis predicts there to be a rather ________ short-run multiplier and thus a rather ________ private economy.

A) low, unstable
B) low, stable
C) high, unstable
D) high, stable

Question 74

Suppose we are working with the simplest possible Keynesian-cross multiplier, but with the permanent-income hypothesis figured in. If k = 0.88, and j = 0.25, the multiplier of a $1 change in government spending goes from ________ in the short run to ________ in the long run.

A) 8.33, 1.28
B) 1.28, 8.33
C) 8.33, 4.00
D) 1.13, 4.00
E) 4.54, 8.33

Question 75

The permanent-income hypothesis can reconcile the cross-section and time-series consumption studies by incorporating the reasonable assumption that at any one time many people are poor because they have ________ transitory income, causing them to have an unusually ________ saving ratio.

A) positive, high
B) positive, low
C) negative, high
D) negative, low

Question 76

In a business cycle boom, we expect an unusually ________ proportion of actual income to be transitory, thus an unusually ________ MPC operating in the short run, which ________ the income multiplier for the short run.

A) high, low, reduces
B) high, low, increases
C) high, high, reduces
D) low, low, increases
E) low, high, reduces

Question 77

In the life-cycle hypothesis, people are assumed to have a consumption pattern that leads them to save

A) at no point in their life.
B) in the working years up to retirement.
C) in their retirement years.
D) in every year of their life.

Question 78

According to the life-cycle hypothesis, if the average person expects to live another 48 years, the short-run MPC out of unexpected changes in income is

A) 0.52.
B) 0.48.
C) 0.9792.
D) 0.0208.

Question 79

The permanent-income hypothesis can reconcile the cross-section and time-series consumption studies by incorporating the reasonable assumption that at any one time many people are rich because they are enjoying unusually high ________ income, causing them to have an unusually ________ saving ratio.

A) permanent, high
B) permanent, low
C) transitory, high
D) transitory, low

Question 80

By the permanent-income hypothesis, for every dollar that actual income increases, consumption expenditure rises in the short run by ________ dollars.

A) kj
B) k + j
C) k/j
D) k - j
E) j + (1/k)