Deck 16: Understanding Consumer Behavior

Question 1

During World War II, economists using John Maynard Keynes's theory predicted that the rate of saving after the war would be very:

A) high, and that is what happened.
B) low, and that is what happened.
C) low, but that did not happen.
D) high, but that did not happen.

Answer 1

high, but that did not happen.

Question 2

Empirical evidence finds that the average propensity to consume is falling:

A) for only the short-run consumption function.
B) for only the long-run consumption function.
C) for both the short-run and the long-run consumption functions.
D) for neither the short-run nor the long-run consumption functions.

Answer 2

for only the short-run consumption function.

Question 3

John Maynard Keynes believed that the average propensity to consume:

A) was constant.
B) increased as income increased.
C) decreased as income increased.
D) was less than the marginal propensity to consume.

Answer 3

decreased as income increased.

Question 4

If the Keynesian consumption function is written as then the average propensity to consume is:

A) c.
B)
C)
D)

Question 5

Empirical evidence finds that the average propensity to consume is constant:

A) for only the short-run consumption function.
B) for only the long-run consumption function.
C) for both the short-run and the long-run consumption functions.
D) for neither the short-run nor the long-run consumption functions.

Question 6

Kuznets' data showed a short-run consumption function with a ______ APC, and a long-run consumption function with a ______ APC.

A) constant; constant
B) constant; falling
C) falling; constant
D) falling; falling

Question 7

The consumer's budget constraint reflects the fact that because interest is earned on savings:

A) future income is worth less than current income.
B) future income is worth more than current income.
C) future consumption costs more than current consumption.
D) future consumption is worth more than future income.

Question 8

John Maynard Keynes believed that the marginal propensity to consume:

A) was zero.
B) was between zero and one.
C) was one.
D) increased as income increased.

Question 9

Simon Kuznets found that, over long periods of time in the United States, as income rose, the average propensity to consume:

A) rose.
B) fell.
C) remained constant.
D) rose and then fell.

Question 10

The consumption decisions of individuals are not important for the:

A) determination of the steady-state capital stock.
B) determination of fiscal-policy multipliers.
C) determination of aggregate demand.
D) determination of sticky prices.

Question 11

A consumer's budget constraint for two periods with positive interest rate r may be represented by the equation:

A) C₁ + C₂ = Y₁ + Y₂.
B) C₁ + C₂/(1 + r) = Y₁ + Y₂/(1 + r).
C) C₁ + C₂(1 + r) = Y₁ + Y₂(1 + r).
D) C₁/(1 + r) + C₂ = Y₁/(1 + r) + Y₂.

Question 12

In Irving Fisher's two-period consumption model, if Y₁ = 20,000, Y₂ = 15,000, and the interest rate r is 0.50 (50 percent), then the maximum possible consumption in period one is:

A) 20,000.
B) 25,000.
C) 30,000.
D) 35,000.

Question 13

In Irving Fisher's two-period consumption model, if Y₁ = 20,000, Y₂ = 15,000, and the interest rate r is 0.50 (50 percent), then the maximum possible consumption in period two is:

A) 15,000.
B) 25,000.
C) 35,000.
D) 45,000.

Question 14

Examination of data from households shows that households with high current income ______ than do households with low current income.

A) consume less
B) save less
C) save a smaller fraction of current income
D) save a larger fraction of current income

Question 15

The Keynesian consumption function exhibits all of the following properties except that:

A) the marginal propensity to consume is between 0 and 1.
B) the average propensity to consume decreases as income increases.
C) only unexpected policy changes influence consumption.
D) current income is the primary determinant of consumption.

Question 16

Which of the following conjectures that underlie the Keynesian consumption function is not consistent with aggregate U.S. data?

A) The marginal propensity to consume is between 0 and 1.
B) The average propensity to consume decreases as income increases.
C) There is a high correlation between income and consumption.
D) Current income is a determinant of consumption.

Question 17

John Maynard Keynes believed that:

A) consumers would save more if the interest rate was high.
B) consumers would consume more if the interest rate was high.
C) if consumers consume less, the interest rate will be high.
D) the interest rate is relatively unimportant to the consumption decision.

Question 18

The average propensity to consume is the:

A) ratio of consumption to income.
B) amount consumed out of an additional dollar of income.
C) amount available for consumption after precautionary saving.
D) ratio of consumption to wealth.

Question 19

The marginal propensity to consume is the:

A) ratio of consumption to income.
B) amount consumed out of an additional dollar of income.
C) amount available for consumption after precautionary saving.
D) ratio of consumption to wealth.

Question 20

Economists based their prediction that secular stagnation would occur as economies prospered on the conjecture that:

A) the marginal propensity to consume is greater than zero.
B) the marginal propensity to consume is less than one.
C) the average propensity to consume falls as income rises.
D) income is the primary determinant of consumption.

Question 21

In Irving Fisher's two-period model, if the consumer is initially a saver and the interest rate and first-period consumption increase, then we can conclude that the income effect:

A) was greater than the substitution effect.
B) was less than the substitution effect.
C) exactly offset the substitution effect.
D) and the substitution both increased consumption.

Question 22

In the Fisher two-period model, if the consumer is a saver, consumption in periods one and two are normal goods, and the income effect of an increase in interest rate is greater than the substitution effect, then saving:

A) will increase.
B) will decrease.
C) will not change.
D) may either increase or decrease.

Question 23

The marginal rate of substitution between first-period consumption and second-period consumption:

A) is the inverse of the slope of an indifference curve, in which first-period consumption is graphed along the horizontal axis.
B) is generally high when first-period consumption is high.
C) indicates by how much first-period consumption changes for a one-unit change in first-period income.
D) reveals the rate at which the consumer is willing to substitute second-period consumption for first-period consumption.

Question 24

A normal good is a good that:

A) provides pleasure.
B) would generally be owned by an average household.
C) has a value greater than zero.
D) is desired in larger quantities by a consumer when his or her income rises.

Question 25

Every indifference curve shows combinations of first-period and second-period consumption that:

A) are tangent to the intertemporal budget constraint.
B) have equal income and substitution effects.
C) are available to the consumer.
D) make the consumer equally happy.

Question 26

In Irving Fisher's two-period model, if the consumer is initially a saver and the interest rate increases, and first-period consumption decreases, then we can conclude that the income effect:

A) was greater than the substitution effect.
B) was less than the substitution effect.
C) exactly offset the substitution effect.
D) and the substitution both decreased consumption.

Question 27

When the consumer has chosen his or her optimal values of first-period and second-period consumption, the marginal rate of substitution equals:

A) 1 plus the interest rate r.
B) 1 minus the interest rate r.
C) 1 divided by the interest rate r.
D) the interest rate r.

Question 28

Use the following to answer questions :
Exhibit: Budget Constraint
(Exhibit: Budget Constraint) Based on the graph, if Y₁ and Y₂ represent income in period one and period two, respectively, at which point along the budget constraint would a consumer be a borrower in period one?

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

Question 29

An increase in income in period one in Irving Fisher's two-period consumption model increases consumption in:

A) period one, but decreases consumption in period two.
B) period one, but does not change consumption in period two.
C) both periods one and two, as long as consumption in period one and consumption in period two are both normal goods.
D) period two, but does not change consumption in period one.

Question 30

In Irving Fisher's two-period model, if consumption in both periods is a normal good, then an increase in income in period two:

A) increases consumption in period one only.
B) increases consumption in period two only.
C) increases consumption in both periods.
D) does not increase consumption in either period.

Question 31

In Irving Fisher's two-period model, the income effect of an increase in the interest rate in the first period for a saver is the:

A) decrease in the relative price of second-period consumption.
B) additional income earned on first-period saving.
C) decrease in the relative price of first-period consumption.
D) additional income earned on second-period saving.

Question 32

In Irving Fisher's two-period model, the substitution effect of an increase in the interest rate in the first period, for a saver, is the:

A) decrease in the relative price of second-period consumption.
B) additional income earned on first-period saving.
C) decrease in the relative price of first-period consumption.
D) additional income earned on second-period saving.

Question 33

In Irving Fisher's two-period model, if the consumer is initially borrowing in period one and the real interest rate rises, first-period consumption will:

A) certainly rise.
B) certainly fall.
C) remain constant.
D) either rise or fall.

Question 34

In John Maynard Keynes's model, the most important determinant of current consumption is current income. In Irving Fisher's model, the most important determinant of current consumption is:

A) also current income.
B) the interest rate.
C) lifetime resources.
D) future income.

Question 35

In Irving Fisher's two-period model, if the consumer is initially saving in period one and the real interest rate rises, then first-period consumption will:

A) certainly fall.
B) certainly rise.
C) remain constant.
D) either rise or fall.

Question 36

In Irving Fisher's two-period model, if the consumer is initially saving in period one and the real interest rate rises, then:

A) both the income and substitution effects will make the consumer want to consume less in period one.
B) both the income and substitution effects will make the consumer want to consume more in period one.
C) the substitution effect will make the consumer want to consume less in period one but the income effect will make him or her want to consume more.
D) the income effect will make the consumer want to consume less in period one, but the substitution effect will make him or her want to consume more.

Question 37

In the Fisher two-period model, the consumer achieves his or her optimum combination of current and future consumption by selecting:

A) any combination on his or her highest indifference curve.
B) the combination on his or her highest indifference curve that is tangent to his or her budget constraint.
C) any combination on his or her budget constraint.
D) the combination on his or her budget constraint in which period-one consumption equals period-one income and period-two consumption equals period-two income.

Question 38

Use the following to answer questions :
Exhibit: Residential Investment
(Exhibit: Budget Constraint) Based on the graph, if Y₁ and Y₂ represent income in period one and period two, respectively, r is the interest rate, and the consumer chooses to consume combination A on the budget constraint, what will be the level of consumption in period two, C₂?

A) Y₁(1 + r) + Y₂
B) Y₁ + Y₂/(1 + r)
C) Y₁/(1 + r) + Y₂
D) Y₁ + Y₂(1 + r)

Question 39

The Fisher two-period model shows that current consumption depends on:

A) only current income.
B) only future income.
C) current income, future income, and the interest rate.
D) current income, future income, the interest rate, and the rate of inflation.

Question 40

The behavior of consumers spreading increases in income earned in one period into increases in consumption over several periods is known as:

A) random-walk consumption.
B) transitory consumption.
C) consumption smoothing.
D) the income effect.

Question 41

In Irving Fisher's two-period model augmented by a borrowing constraint, an example of a consumer for whom the borrowing constraint might likely be binding would be:

A) a college student.
B) a college student's parent.
C) a college professor.
D) the president of a bank.

Question 42

According to the life-cycle model, when wealth and income increase together in the long run, the average propensity to consume.

A) increases
B) decreases
C) remains constant
D) can either increase or decrease

Question 43

According to the life-cycle model, the short-run consumption function will not continue to hold in the long run because:

A) increases in wealth shift the short-run function upward.
B) decreases in the average propensity to consume shift the short-run function downward.
C) increases in income shift the short-run function upward.
D) increases in the average life span shift the short-run function upward.

Question 44

According to the life-cycle model, the average propensity to consume does not fall as income increases in the long run because:

A) wealth and income grow together.
B) as income increases wealth decreases.
C) saving is constant over the life cycle.
D) wealth is constant over the life cycle.

Question 45

According to Franco Modigliani's life-cycle hypothesis, the principal determinant(s) of consumption is (are):

A) permanent income.
B) income and wealth.
C) transitory income.
D) wealth.

Question 46

According to Modigliani's life-cycle hypothesis, if a consumer wants equal consumption in every year and the interest rate is zero, then the marginal propensity to consume out of wealth ______ as years ______ decrease.

A) increases; of life remaining
B) decreases; of life remaining
C) increases; until retirement
D) decreases; until retirement

Question 47

According to Franco Modigliani's life-cycle hypothesis, the time of life at which an individual has the largest amount of wealth is at:

A) birth.
B) death.
C) retirement.
D) his or her parents' death.

Question 48

The life-cycle model assumes that consumers use saving and borrowing to ______ consumption over their life cycle.

A) increase
B) decrease
C) smooth
D) vary

Question 49

According to Modigliani's life-cycle hypothesis, the consumption function shifts upward as _____ increases.

A) income
B) wealth
C) the marginal propensity to consume out of income
D) the number of years until retirement

Question 50

A borrowing constraint that is not binding occurs when a consumer wants to consume ______ in period one than he or she earns in period(s) _____.

A) less; one
B) more; one
C) less; one and two
D) more; one and two

Question 51

If a consumer is in a position in which a borrowing constraint limits his or her current consumption and a one-time tax is levied on his or her current income, then the tax will:

A) lower the consumer's future consumption.
B) not affect the consumer's future consumption.
C) increase the consumer's future consumption.
D) have no effect on either current or future consumption.

Question 52

A consumption function based on the Fisher two-period model is consistent with the Keynesian consumption function for consumers who:

A) would like to borrow, but cannot.
B) are initially borrowers when future income increases.
C) are initially savers when future income increases.
D) are initially borrowers when the interest rate increases.

Question 53

According to the life-cycle model, when wealth is constant in the short run, the average propensity to consume ______ as income increases.

A) increases
B) decreases
C) remains constant
D) can either increase or decrease

Question 54

In Irving Fisher's two-period consumption model, if Y₁ = 15,000, Y₂ = 20,000, the interest rate r is 0.50 (50 percent), and there is a constraint on borrowing that is binding, then C₁ equals:

A) 15,000.
B) 20,000.
C) 28,333.
D) 35,000.

Question 55

In Irving Fisher's two-period consumption model, if Y₁ = 15,000, Y₂ = 20,000, the interest rate r is 0.50 (50 percent), and there is a constraint on borrowing that is binding, then C₂ equals:

A) 20,000.
B) 22,500.
C) 35,000.
D) 42,500.

Question 56

If a consumer cannot borrow, then consumption in period one must be ______ income in period(s) _____.

A) less than; one
B) less than or equal to; one
C) less than; one and two
D) less than or equal to; one and two

Question 57

In Irving Fisher's two-period model, consumption for a consumer with a binding borrowing constraint equals an amount that is:

A) equal to current income.
B) greater than current income.
C) equal to future income.
D) greater than future income.

Question 58

In the Fisher two-period model, if the consumer is a saver, consumption in periods one and two are normal goods, and the income effect of an increase in interest rate is less than the substitution effect, then saving:

A) will increase.
B) will decrease.
C) will not change.
D) may either increase or decrease.

Question 59

Franco Modigliani's life-cycle hypothesis puts great emphasis on saving for:

A) a house.
B) a car.
C) retirement.
D) medical emergencies.

Question 60

Franco Modigliani's answer to Simon Kuznets's puzzle regarding long-term constancy of the average propensity to consume is that:

A) the average propensity to consume depends on the wealth-to-income ratio, and income and wealth tend to grow together over time.
B) both rich and poor individuals have the same average propensity to consume.
C) demographic shifts have acted to just cancel out movements in the average propensity to consume.
D) every consumer consumes all of his or her income over a lifetime, so the average propensity to consume is constant at one.

Question 61

Consumption is said to follow a random walk if:

A) consumers have rational expectations.
B) consumption is proportional to permanent income.
C) changes in consumption are unpredictable.
D) changes in consumption produce secular stagnation.

Question 62

If the permanent-income hypothesis is correct, and if consumers have rational expectations, then changes in consumption over time should be:

A) predictable.
B) unpredictable.
C) mostly positive.
D) mostly negative.

Question 63

Milton Friedman argued that, on average, consumption is:

A) proportional to income.
B) a fraction of permanent income that rises as permanent income rises.
C) a fraction of permanent income that falls as permanent income falls.
D) proportional to permanent income.

Question 64

According to the permanent-income hypothesis, if consumers receive a permanent increase in their salary then they will:

A) save most of it in the current year.
B) spend most of it in the current year.
C) spend one half of it and save one-half of it in the current year.
D) not alter their consumption or saving in the current year.

Question 65

According to Friedman's permanent-income hypothesis, the marginal propensity to consume out of permanent income is ______ the marginal propensity to consume out of transitory income.

A) greater than
B) less than
C) equal to
D) one minus

Question 66

If consumers obey the permanent-income hypothesis and have rational expectations, then ______ policy changes influence consumption.

A) only unexpected
B) only expected
C) both expected and unexpected
D) neither expected nor unexpected

Question 67

Milton Friedman viewed current income as the sum of permanent income and:

A) bonus income.
B) transitory income.
C) temporary income.
D) surprise income.

Question 68

According to the permanent income hypothesis, households will finance a temporary increase in taxes by: reducing _______ or increasing _____.

A) consumption; saving
B) saving; borrowing
C) permanent income; transitory income
D) transitory income; permanent income

Question 69

Permanent and transitory incomes differ in the way that permanent income is ______ than is transitory income.

A) larger
B) more persistent
C) taxed at a higher rate
D) more variable

Question 70

If consumers obey the permanent-income hypothesis and have rational expectations, then policy changes affect consumption when the policy changes:

A) are proposed.
B) go into effect.
C) change expectations.
D) do not surprise consumers.

Question 71

According to the permanent-income hypothesis, consumption depends primarily on ______ income.

A) current
B) nominal
C) permanent
D) transitory

Question 72

According to the permanent-income hypothesis, if consumers receive a one-time income bonus, then they will:

A) save most of it in the current year.
B) spend most of it in the current year.
C) spend one half of it and save one-half of it in the current year.
D) not alter their consumption or saving in the current year.

Question 73

Milton Friedman argued that, over long periods of time, the average propensity to consume is constant because, over these long periods of time:

A) the variation in income is dominated by the transitory component
B) the variation in income is dominated by the permanent component.
C) it is the behavior of the average consumer that dominates.
D) income averages out to a constant.

Question 74

If consumers have rational expectations and follow the permanent-income hypothesis, their current consumption will increase when:

A) previously announced tax reductions are implemented.
B) they receive an anticipated raise.
C) they receive an unexpected inheritance.
D) they make the last payment on their automobile loan.

Question 75

Precautionary saving is saving for:

A) retirement, when income falls.
B) unpredictable expenses.
C) bequests to benefit children.
D) repayment of debt previously incurred.

Question 76

According to Friedman's permanent-income hypothesis, if the marginal propensity to consume out of permanent income equals 0.9 and current income equals $55,000 (of which $5,000 is transitory income), then consumption should equal:

A) $5,000.
B) $45,000.
C) $49,500.
D) $55,000.

Question 77

Milton Friedman argued that, although household studies showed that high-income households generally have lower average propensities to consume, this phenomenon is due to the fact that these households have, on average:

A) positive transitory income.
B) negative transitory income.
C) higher permanent income.
D) lower permanent income.

Question 78

Suppose that the government is considering two tax cuts, one temporary and one permanent. Each cut will give each taxpayer the same amount in the first year. The permanent-income hypothesis predicts that:

A) each tax cut will lead to the same amount of consumption in the first year.
B) the temporary tax cut will lead to more extra consumption in the first year.
C) the permanent tax cut will lead to more extra consumption in the first year.
D) the temporary tax cut will lead to no extra consumption at all in the first year.

Question 79

Transitory income is:

A) income that persists.
B) average income.
C) random deviations from average income.
D) current income.

Question 80

Empirical studies of Franco Modigliani's life-cycle hypothesis show that:

A) most elderly individuals try to exhaust all their savings by the time they die.
B) the elderly do not seem to run down their wealth in old age, as a simple version of the theory would predict.
C) elderly individuals generally do not want to leave bequests for their children.
D) precautionary saving is not an important saving motive for the elderly.