Deck 16: Household and Firm Behavior in the Macroeconomy: a Further Look

Question 1

Under what condition is a change in tax rates likely to affect individuals' behavior regarding consumption and saving?

Answer 1

The tax rate change is likely to affect individuals' behavior regarding consumption and saving if the tax cut is permanent .

Question 2

What does the empirical evidence suggest about the shape of the labor supply curve?

Answer 2

The substitution effect seems to dominate for most people, which means that the aggregate labor supply responds positively to an increase in the wage rate. It is therefore, an upsloping function.

Question 3

Consider the effect of a fall in the interest rate on consumption. Explain your answer using the substitution effect argument.

Answer 3

A fall in the interest rate lowers the reward to saving. If the interest rate falls from 10 percent to 5 percent, you earn 5¢ instead of 10¢ per year on every dollar saved. This means that the opportunity cost of spending a dollar today (instead of saving it and consuming it plus the interest income a year from now) has fallen. You will substitute toward current consumption and away from future consumption when the interest rate falls: You consume more today and save less.

Question 4

Assume an individual whose income rises at a decreasing rate up until midlife and then falls at an increasing rate. In addition, assume that her consumption is constant throughout her lifetime. With this information, draw her income and consumption functions as a function of age. Explain what is going on in each part of her life.

Question 5

To calculate the real wage rate, we divide the nominal wage rate by the price index. Suppose the wage rate rose from $10 per hour in 1998 to $18 per hour in 2010 and the price level rose 50 percent during the same period. Calculate the real wage rate in 2010 using 1998 as the base year. Show your work.

Question 6

Consider the effect of a fall in the interest rate on consumption. Explain your answer using the income effect argument. Make sure to compare and contrast the effects between a household with positive wealth and a household that is a net debtor.

Question 7

Define the nominal wage rate.

Question 8

A candidate is running for public office and is against making any tax cuts because of a concern that this will lead to lower tax revenue and a higher budget deficit. His aides have told him that studies have shown that the income effect dominates the substitution effect along the labor supply curve. If this is true does this support the candidate's position on cutting taxes if his goal is to insure that tax revenue does not fall? Explain.

Question 9

A candidate is running for public office and has made a pledge to cut taxes. His aides have told him that studies have shown that the substitution effect dominates the income effect along the labor supply curve. If this is true does this support the candidate's position on cutting taxes if his goal is to increase tax revenue? Explain.

Question 10

Assume that you are an aide to a politician. Explain to your boss what would happen to the shape of the labor supply curve if the income effect is dominating the substitution effect.

Question 11

Consider a household that has a sudden unexpected increase in wealth, perhaps an inheritance from a distant relative. How will the household's consumption pattern be affected?

Question 12

How is it that people are able to consume greater than their income during their early working careers? What are some of the things that they consume which causes this to happen in the first place?

Question 13

Consider two households that are at the same stage in their life cycle and have similar expectations about future wage rates, prices, and so on. They expect to live the same length of time, and both plan to leave the same amount to their children. They differ only in their wealth. Because of a past inheritance, household 1 has more wealth than household 2. Which household is likely to have a higher consumption path for the rest of its life?

Question 14

What is permanent income?

Question 15

What does the data suggest about the relative impact of the substitution effect and income effect of a change in interest rates on consumption and saving?

Question 16

Assume that Congress passes a one-year 10% across-the-board tax cut. What would the life-cycle theory suggest about this tax cut's effectiveness on the economy?

Question 17

Explain the life-cycle theory of consumption.

Question 18

How is it possible to have negative wealth?

Question 19

What would be the shape of the labor supply curve if the substitution effect was exactly equal to the income effect? Explain. How realistic is a labor supply curve of this shape?

Question 20

Why is a medical student likely to consume more than a high school student?

Question 21

Assume that the substitution effect dominates. Explain the impact of an increase in income taxes on labor supply.

Question 22

Define the real wage rate.

Question 23

Refer to the information provided in the table below to answer the questions that follow.

Refer to the above table. What is the real wage rate in 2008 using 2007 as the base year? Make sure to show your work.

Question 24

Refer to the information provided in the table below to answer the questions that follow.

Refer to the above table. What is the real wage rate in 2007 using 2006 as the base year? Make sure to show your work.

Question 25

Explain why it is not unambiguously clear that the labor supply is an upward-sloping function of the wage rate.

Question 26

Using the income effect, explain the likely impact of a decrease in the interest rate on household consumption for an individual with positive wealth.

Question 27

Assume people have positive wealth. Explain how the income effect of an increase in interest rates can affect consumption.

Question 28

Suppose that a factory worker receives an increase in his wage rate of 15 percent over the next year. In addition, suppose that the price of the goods and services he consumes rises by 10 percent. How much has this factory worker's real wage changed by?

Question 29

Explain how an increase in the wage rate might cause the people to work less. Make use of the income effect in explaining your answer.

Question 30

Explain why a higher wage rate might lead to a larger labor supply. Make sure to use opportunity costs and the substitution effect to demonstrate your point.

Question 31

Draw a graph of labor supply in which the substitution effect dominates at low wages and the income effect eventually dominates at higher wages.

Question 32

Why is it not obvious what will be the impact of a decline in the interest rate on present consumption?

Question 33

What is meant by nonlabor or nonwage income? Please give examples.

Question 34

Why is it that consumption and labor supply decisions cannot be considered separately?

Question 35

Changes in interest rates result in both an income effect and a substitution effect. What does the empirical evidence suggest about their relative strengths? Morever, what is the likely effect on consumption? You may also wish to comment on what is happening to the income effect over time and what is driving this change.

Question 36

Refer to the information provided in the table below to answer the questions that follow.

Refer to the above table. Why is that nominal wages have increased between 2007 and 2008 but real wages have fallen? Explain how this is possible.

Question 37

Assume that Brenda has positive wealth. As the interest rate decreased, Brenda reduced her current consumption. What can we conclude is true about the relative strength of the income effect and substitution effect for Brenda?

Question 38

Using the income effect, explain the likely impact of a decrease in the interest rate on household consumption for an individual who is a debtor.

Question 39

Assume that the substitution effect dominates. Explain the impact of a decrease in income taxes on labor supply.

Question 40

Using the substitution effect, explain the likely impact of a decrease in the interest rate on household consumption.

Question 41

What is the usual and expected relationship between changes in wealth and the labor supply?

Question 42

Investment decisions require looking into the future and forming expectations about it. In forming their expectations, firms consider numerous factors. Discuss these factors.

Question 43

Explain why the presence of significant adjustment costs might induce a firm to hold excess labor. Would you expect adjustments costs to be high or low in a firm whose workers' skills are very specific to the firm? Explain.

Question 44

Write a list of five factors that affect household consumption and labor supply decisions:
·

Question 45

Using the life-cycle theory of consumption, explain each of the following:
(a) Mary and Tom both earn $15,000. Mary spends $30,000 a year and Tom spends $14,000 a year. Mary is working on her MBA degree and Tom, a high school dropout, works as a window washer.
(b) Paul's current income has not changed, but he becomes pessimistic about the economy and worries about losing his job. As a result, he reduces his current consumption.

Question 46

Explain the life-cycle theory of consumption. How does it differ from the Keynesian theory of consumption?

Question 47

Why is it that housing investment fell sharply during the three recessionary periods since 1970?

Question 48

Compare and contrast the labor force participation rates between men and women since 1970.

Question 49

Define the constrained supply of labor.

Question 50

Explain what impact each of the following is likely to have on consumption.
(a) Stock prices fall.
(b) The government announces that in 2014 and only in 2014 every family will have to pay an additional lump-sum tax of $100.
(c) Most economic forecasts indicate that the growth rate will slow down considerably over the next decade.

Question 51

Explain how a decrease in taxes and increase in transfer payments affect consumption and labor supply.

Question 52

What is the optimal level of inventories? What are the costs of holding inventories? What are the benefits of holding inventories? How will an increase in interest rates affect the optimal level of inventories?

Question 53

Define and explain the difference between the income and substitution effects in relation to changes in income tax rates.

Question 54

Explain the accelerator effect.

Question 55

How does a household respond when it is constrained from working as much as it would like? Explain with the use of an example.

Question 56

Explain the difference between the unconstrained supply of labor and the constrained supply of labor. Why doesn't a household have control over its constrained supply of labor?

Question 57

Define the unconstrained supply of labor.

Question 58

Rick has net assets of $50,000. How will an increase in the interest rate affect Rick's consumption? How will your answer change if Rick's fortunes change and his net assets fall to -$10,000?

Question 59

Households make consumption and labor supply decisions simultaneously. Explain why.

Question 60

What did Keynes mean by the phrase "animal spirits of entrepreneurs"? Why do these "spirits" make investment a volatile component of GDP?

Question 61

What is the impact on future production of an unexpected increase or decrease in inventories?

Question 62

Refer to the figure above. What could cause a movement from Point B to Point C?

Question 63

Although the stock of inventories fluctuates over time because production is smoothed relative to sales, at any point in time, inventories may be unexpectedly high or low because sales have been unexpectedly low or high. Explain how this is likely to affect future production.

Question 64

What is meant by "desired" or "optimal" level of inventories?

Question 65

How can inventory investment be a negative figure?

Question 66

When forming their expectations, firms gather information about several factors. Name three of those factors that would be important.

Question 67

What does it mean to have excess labor and excess capital?

Question 68

Suppose a firm suffers a sudden and large decrease in sales, but it expects the lower sales level to last only a few months, after which it believes sales will pick up again. Explain how the firm will react with respect to its labor force and its production.

Question 69

Explain why a firm may choose not to lay off workers during a decline in sales.

Question 70

Refer to above figure. Suppose the economy is currently at Point B. If investors are optimistic about future growth in GDP what would you expect to happen?

Question 71

Refer to the above figure. Assume the the investment demand curve is currently at I₃. Describe what would happen if there was an increase in GDP due to the accelerator effect.

Question 72

What are the adjustment costs to a firm when it increases output?

Question 73

When the inventory/sales ratio is high, the actual stock of inventories is likely to be larger than the desired stock. Explain the economic consequences of this.

Question 74

Define inputs.

Question 75

What is plant-and-equipment investment?

Question 76

Refer to the figure above. What could cause a movement from Point C to Point B?

Question 77

Assume the unemployment rate does not tend to fall as soon as the economy pulls out of a recession. What would be a good explanation for this?

Question 78

Explain inventory investment.

Question 79

What are adjustment costs?

Question 80

Assume a firm finds that its adjustment costs are large enough tht it decides not to decrease its workforce and capital stock when production falls. What is the consequence of this action to the firm?