Deck 16: Expectations,consumption,and Investment

Question 1

Assume the following: (1)the real cost of a unit of capital is one; (2)the unit of capital is expected to increase a firm's real profit by $10,000 each year,and depreciate by 8% each year (δ = .08); and (3)The real interest rate is 2% (r = .02).What is the "user cost" or "rental cost" of this unit of capital?

A).02
B).06
C).10
D).08 / .02 = 4
E)none of the above

Answer 1

C

Question 2

Which of the following will cause an increase in the rental cost / user cost of capital?

A)the rate of depreciation increases.
B)the real interest rate decreases.
C)the expected profit from the machine decreases.
D)all of the above
E)none of the above

Answer 2

E

Question 3

The "life cycle" and "permanent income" theories of consumption share which of the following features?

A)consumption spending depends on income,rather than wealth.
B)consumption spending should fluctuate widely from year to year.
C)consumers look ahead to the future in making current spending decisions.
D)all of the above
E)none of the above

Answer 3

C

Question 4

A painting is currently worth $100,000,and is expected to maintain its real value for three years.The real interest rate is expected to remain constant at 10%.What is the present value of the painting's expected price at the end of the third year?

A)$75,131
B)$88,899
C)$96,153
D)$100,000
E)$70,000

Question 5

Which of the following will cause the rental cost / user cost of capital to decrease?

A)the rate of depreciation decreases.
B)the real interest rate increases.
C)the expected profit from the machine decreases.
D)all of the above
E)none of the above

Question 6

Human wealth is

A)the present discounted value of expected future after-tax labor income.
B)the sum of financial and housing wealth.
C)the discounted present value of all financial assets.
D)financial wealth minus housing wealth.
E)total wealth minus housing wealth.

Question 7

Which of the following represents non-human wealth?

A)total wealth minus housing wealth
B)total wealth minus financial wealth
C)wealth that cannot be taken from a person,by law
D)financial wealth minus housing wealth
E)none of the above

Question 8

Which of the following best defines total wealth?

A)financial wealth only
B)financial wealth and housing wealth only
C)human wealth only
D)non-human wealth and human wealth
E)none of the above

Question 9

Which of the following would cause an increase in human wealth?

A)a permanent increase in salary
B)an increase in the value of one's house
C)an increase in the value of one's stock portfolio
D)all of the above
E)none of the above

Question 10

The "depreciation rate" tells us

A)the interest rate that should be used in present discounted value calculations.
B)the rate at which consumers deplete their total wealth in retirement.
C)the difference between current and expected income.
D)the difference between current and expected profits.
E)how much usefulness a machine loses from year to year.

Question 11

For this question,ignore tax considerations of each of the following.Assume that consumption decisions are made according to the permanent income theory.Which of the following would lead to the smallest increase in current consumption?

A)winning $10,000 in the lottery
B)inheriting $10,000 from a relative
C)obtaining $10,000 by winning a lawsuit
D)getting a one-time $10,000 bonus from your employer
E)all of the above

Question 12

Consumption is most likely to respond one-for-one with changes in current income when

A)the change in current income results from a one-time bonus
B)people believe the change in their current income is temporary.
C)people are able to borrow as much as they wish,as long as they pay it back.
D)the change in current income is caused by the business cycle.
E)none of the above

Question 13

Which of the following is a reason that consumption depends on current income,and not just on total wealth?

A)banks will not always lend money to those who want to consume more than their income.
B)the anticipation of future financial distress makes some people reluctant to borrow.
C)low income people may prefer to postpone some consumption until later years,when their incomes are higher.
D)all of the above
E)none of the above

Question 14

The data shows that total profit in the U.S.economy

A)has decreased steadily over time.
B)is not influenced by the business cycle.
C)tends to decrease in recessions,increase in expansions.
D)tends to increase in recessions,decrease in expansions.
E)tends to increase in even years,and decrease in odd years,although no one can explain why.

Question 15

The data for the U.S.show that investment and profits

A)have a strong negative relationship.
B)are positively related during recessions,and negatively related during expansions
C)move independently.
D)are positively related during expansions,and negatively related during recessions.
E)none of the above

Question 16

A change in which of the following variables would affect the cash flow for a firm?

A)changes in the nominal interest rate
B)expected future profit
C)changes in the real interest rate
D)changes in expected inflation
E)none of the above

Question 17

Which of the following people-none of whom has any financial or housing wealth-is most likely to be spending all of their current income?

A)a low income person expecting continued low income throughout life
B)a low income person expecting a dramatic rise in income in the future
C)a high income person expecting continued high income throughout life
D)a high income person expecting a dramatic drop in income in the future
E)a high income person expecting to retire soon,and live for a long time afterward

Question 18

An economist conducts a "natural experiment" by

A)choosing two groups of people - a control group and a test group - and providing special treatment for the test group.
B)using animal behavior to make inferences about human behavior.
C)using his or her own intuition to surmise what people will do in a given situation.
D)polling other economists to see if they believe a theory.
E)taking real-world data as it is given,and using it to test a theory.

Question 19

Which of the following is evidence that consumption depends on total wealth,and not just on current income?

A)people save very little for their retirement.
B)the pre-announced phased-in tax cuts of 1981-83 caused little change in consumption in 1981.
C)a drop in consumer confidence,with unchanged current income,often causes total consumption spending to fall.
D)all of the above
E)none of the above

Question 20

Figures on "mean wealth" of the elderly (ages 65-69)show that most wealth consists of

A)home equity
B)personal savings
C)stocks and bonds
D)social security benefits
E)collectibles,like stamps,coins and art

Question 21

An increase in which of the following variables will cause an increase in the user cost of capital?

A)δ
B)Πt
C)Πet
D)all of the above
E)none of the above

Question 22

For this question,assume that firms experience an increase in sales.We would expect that this increase in sales will cause

A)an increase in profit per unit of capital.
B)a decrease in profit per unit of capital.
C)no change in profit per unit of capital.
D)ambiguous effects on profit per unit of capital.
E)none of the above

Question 23

An increase in which of the following variables should cause an increase in profit per unit of capital?

A)total wages and salaries
B)total sales
C)the capital stock
D)the ratio of total sales to the capital stock
E)the ratio of total sales to total wages and salaries

Question 24

An increase in which of the following variables will cause an increase in the user cost of capital?

A)rt
B)Πt
C)Πet
D)all of the above
E)none of the above

Question 25

Which of the following will occur when the capital stock increases?

A)profit per unit of capital will increase
B)profit per unit of capital will decrease
C)there will be no change in profit per unit of capital
D)there will be an ambiguous effect on profit per unit of capital
E)none of the above

Question 26

As of 2005,some analysts were concerned that there was a "bubble" in the U.S.housing market.Suppose there is a reduction in real estate prices.This reduction in real estate prices would have the most direct effect on which of the following types of wealth?

A)financial wealth
B)housing wealth
C)human wealth
D)none of the above

Question 27

Suppose that,when the price of steel drops,steel companies tend to cut back on investment in their non-steel activities more than other firms in these same non-steel activities.This would support the idea that

A)cash flow matters for investment.
B)cash flow does not matter for investment.
C)business firms do not care about profit.
D)business firms do not care about interest rates.
E)business firms do not use discounting.

Question 28

Which of the following individuals is responsible for developing the permanent income theory of consumption?

A)Friedman
B)Modigliani
C)Keynes
D)Lucas

Question 29

Which of the following will occur when the capital stock falls?

A)profit per unit of capital will increase
B)profit per unit of capital will decrease
C)there will be no change in profit per unit of capital
D)there will be an ambiguous effect on profit per unit of capital
E)none of the above

Question 30

Suppose current sales increase by $100 million.Investment theory suggests that current investment must

A)decrease exactly by $100 million.
B)increase by exactly $100 million.
C)increase by less than $100 million.
D)decrease,but by less than $100 million.
E)none of the above

Question 31

Suppose there is an increase in income.This increase in income would have a direct effect on which of the following?

A)financial wealth
B)housing wealth
C)human wealth
D)all of the above

Question 32

The reduction in stock prices will have the most direct effect on which of the following types of wealth?

A)financial wealth
B)housing wealth
C)human wealth
D)none of the above

Question 33

Which of the following individuals is responsible for developing the life cycle theory of consumption?

A)Friedman
B)Modigliani
C)Keynes
D)Lucas

Question 34

Suppose an individual experiences a $20,000 increase in real income and the individual believes this increase in income is permanent.Economic theory suggests that this individual's current consumption will

A)remain unchanged.
B)increase by more than $20,000.
C)increase by at most $20,000.
D)decrease or remain unchanged,depending on the value of the real interest rate.
E)decrease,remain unchanged,or increase,depending on the value of the real interest rate.

Question 35

Which of the following statements is true?

A)a change in sales should have more impact on current investment if it is expected to be permanent rather than temporary.
B)on a percentage basis,investment is more volatile than consumption.
C)in terms of dollars,investment and consumption are about equally volatile.
D)all of the above
E)none of the above

Question 36

Human wealth is a function (i.e.,affected by changes in)of which of the following variables?

A)future expected income
B)future expected taxes
C)current interest rates
D)all of the above
E)none of the above

Question 37

Suppose you are given a rare antique by a long-lost relative.The value of this rare antique would be included in which of the following types of wealth?

A)financial wealth
B)housing wealth
C)human wealth
D)none of the above

Question 38

Suppose there is a tax cut.This tax cut would have a direct effect on which of the following?

A)financial wealth
B)housing wealth
C)human wealth
D)none of the above

Question 39

A reduction in sales will generally cause

A)an increase in profit per unit of capital.
B)a decrease in profit per unit of capital.
C)no change in profit per unit of capital.
D)ambiguous effects on profit per unit of capital.
E)none of the above

Question 40

The user cost of capital is represented by which of the following variables?

A)Πt
B)rt
C)1 / (rt + δ)
D)Πt / ( rt + δ)
E)none of the above

Question 41

Explain why current consumption might change even if current income does not change.

Question 42

Investment depends on

A)current profit.
B)present value of of expected future profits.
C)user cost of capital.
D)all of above
E)both A and B

Question 43

Discuss the various components of wealth.

Question 44

Investment accounts for ________ of US GDP.

A)15%
B)20%
C)50%
D)70%

Question 45

Explain what decisions and calculations a very foresighted consumer must make to determine her consumption decisions in any period.

Question 46

Suppose there is a reduction in cash flow.This suggests that

A)firms have decreased their expectations of future profits.
B)the real interest rate has increased.
C)the rate of depreciation has increased.
D)current profits have decreased.
E)all of the above

Question 47

Suppose a firm has 100 machines and 100 shares outstanding.The price per share is $2,and the purchase price of a machine is $1.So Tobin's q is equal to

A)2.
B)1.
C)0.5.
D)1.5.

Question 48

A reduction in which of the following variables will cause a reduction in the user cost of capital?

A)δ
B)Πt
C)Πet
D)all of the above
E)none of the above

Question 49

A reduction in the rate of depreciation will cause the discounted present value of expected profits to

A)decrease.
B)increase.
C)remain unchanged if the real interest rate increases by the same amount.
D)none of the above

Question 50

Which of the following events would likely cause the largest reduction in current consumption?

A)a permanent reduction in annual salary of $2000
B)a one-time tax increase of $4000
C)a one-time reduction in income (e.g.a bonus)of $4000
D)both B and C

Question 51

For this question,assume that firms experience a reduction in sales.We would expect that this decrease in sales will cause

A)an increase in profit per unit of capital.
B)a decrease in profit per unit of capital.
C)no change in profit per unit of capital.
D)ambiguous effects on profit per unit of capital.
E)none of the above

Question 52

Which of the following will cause a reduction in current consumption?

A)a reduction in current disposable income
B)a reduction in financial wealth
C)a reduction in human wealth
D)all of the above
E)both B and C

Question 53

Which of the following will cause an increase in current consumption?

A)an increase in current disposable income
B)an increase in financial wealth
C)an increase in human wealth
D)all of the above
E)both B and C

Question 54

Which of the following statements about consumption and investment is correct?

A)consumption is more volatile than investment.
B)investment and consumption exhibit approximately the same degree of volatility.
C)a permanent change in income will have a relatively larger effect on consumption than on investment.
D)none of the above

Question 55

Which of the following would cause a reduction in human wealth?

A)a permanent reduction in salary
B)a reduction in the value of one's house
C)a reduction in the value of one's stock portfolio
D)all of the above
E)none of the above

Question 56

Suppose there is an increase in profitability.This suggests that

A)firms have increased their expectations of future profits.
B)the real interest rate has increased.
C)the rate of depreciation has increased.
D)all of the above

Question 57

An increase in the rate of depreciation will cause the discounted present value of expected profits to

A)decrease.
B)increase.
C)remain unchanged if the real interest rate increases by the same amount.
D)none of the above

Question 58

Which of the following events would likely cause the largest increase in current consumption?

A)a permanent increase in annual salary of $2000
B)a one-time tax cut of $4000
C)a one-time increase in income (e.g.a bonus)of $4000
D)both B and C

Question 59

Explain why current consumption is likely to respond less than one for one to changes in current income.

Question 60

A reduction in which of the following variables will cause a reduction in the user cost of capital?

A)rt
B)Πt
C)Πet
D)all of the above
E)none of the above

Question 61

First,briefly explain what the user cost or rental cost of capital represents.Second,explain what factors would cause an increase in the user cost or rental cost of capital.

Question 62

What is Tobin's q? How tight is the relation between Tobin's q and investment?

Question 63

Suppose individuals expect future output to be higher and future interest rates to be higher.Given this information,how will individuals alter consumption in the current period? Explain.

Question 64

Suppose firms expect future output to be higher and future interest rates to be higher.Given this information,how will firms alter investment in the current period? Explain.

Question 65

Suppose firms expect future output to be lower and future interest rates to be lower.Given this information,how will firms alter investment in the current period? Explain.

Question 66

Suppose individuals expect future output to be lower and future interest rates to be lower.Given this information,how will individuals alter consumption in the current period? Explain.

Question 67

Explain how expectations affect consumption.

Question 68

Explain what decisions and calculations a firm must make when it is considering the purchase of new capital (i.e.,making an investment decision).

Question 69

Explain how a change in expected future output could affect current output.

Question 70

Explain why consumption is less volatile than investment.

Question 71

Are changes in consumption and investment typically occur in the same direction and at roughly the same magnitude? Explain.

Question 72

Explain each of the determinants of the present value of expected profits from a buying a new machine.

Question 73

Explain the difference between "profitability" and "cash flow".