Question 1

The effect of an increase in current consumption that results when a higher real interest rate makes a consumer richer is called

Accepted Answer

A)  the substitution effect of the real interest rate on saving. 
B)  the income effect of the real interest rate on saving. 
C)  the net effect of the real interest rate on saving. 
D)  the substitution effect of the real interest rate on consumption.

Question 2

Consider a Keynesian consumption function with desired consumption equal to 0.9 Y, where Y is income. Government purchases are $1000, net exports are zero, and desired investment varies with real interest rate according to the following schedule: $$\begin{array} { c c } 
r & I d \
5 \% & \$ 3000 \
4 \% & 3500 \
3 \% & 4000 \
2 \% & 4500
\end{array}$$ Assume the interest rate adjusts so that the economy gets to equilibrium. Equilibrium output at full employment is $50,000. Find the values of consumption, investment, and the real interest rate at full-employment equilibrium.

Accepted Answer

The answer of Consider a Keynesian consumption function with desired...

Question 3

A lump-sum increase in current taxes would cause interest rates to

Accepted Answer

A)  fall if Ricardian equivalence held. 
B)  fall if Ricardian equivalence did not hold. 
C)  fall regardless of whether Ricardian equivalence held. 
D)  rise.

Question 4

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 20% rate, machine C costs $10,000 and depreciates at a 10% rate, and machine D costs $17,000 and depreciates at an 11% rate. The expected real interest rate is 0%.

Accepted Answer

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

Question 5

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

Accepted Answer

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

Question 6

In 2001 the federal government changed the withholding amounts for personal taxes. The change meant that people wouldn't have as much withheld from their paycheques. But there was no change in the tax code itself, so the amount of tax due in April 2002 was not changed. How would consumption and saving respond to this withholding change (note: you may assume a real interest rate of 0%)?

Accepted Answer

The answer of In 2001 the federal government changed the...

Question 7

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

Accepted Answer

A)  There may be international capital inflow and outflows. 
B)  Consumers may not understand that increased 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 8

A technological improvement will

Accepted Answer

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 9

The lesson to be learned from the Ricardian equivalence proposition is that

Accepted Answer

A)  only government budget deficits generated by tax changes affect the macroeconomy. 
B)  government budget deficits do not affect the macroeconomy. 
C)  it is impossible for the government to actually reduce taxes. 
D)  the basic measure of the cost of government is the real resources that the government uses.

Question 10

If you lend money to the government by buying a one-year Treasury bill, your interest rate is 4%, but if you lend money to XYZ corporation by buying a one-year XYZ bond, you can earn 7%. What is the main reason for this difference in interest rates?

Accepted Answer

A)  higher tax rate on the XYZ bond 
B)  higher inflation on the XYZ bond 
C)  higher default risk on the XYZ bond 
D)  higher expected real after-tax rate of return on the XYZ bond

Question 11

Calculate the after-tax user cost of capital of a machine that costs $5000 and depreciates at a 25% rate, when the interest rate is 5% and the tax rate on revenue is 25%.

Accepted Answer

A)  $200 
B)  $275 
C)  $2000 
D)  $2750

Question 12

An increase in the expected real interest rate tends to

Accepted Answer

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

Question 13

The one-year T-bill rate was 8% on 1/1/00, 7% on 1/1/01, and 6% on 1/1/02. The GDP deflator (1996 = 100) was 150 on 1/1/00, 159 on 1/1/01, 165.4 on 1/1/02, and 173.6 on 1/1/03. The tax rate on interest income is 30%.
a. Calculate the after-tax nominal rate of return for 2000, 2001, and 2002.
b. If you began with $1000 on 1/1/00 and invested in T-bills each year (paying taxes at the end of each year), how much would you have in nominal terms on 1/1/01? How much would you have in real terms (1996 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 after-tax dollars?

Accepted Answer

The answer of The one-year T-bill rate was 8% on...

Question 14

What key change in 1975-87 led to a faster growth rate of equipment relative to structures?

Accepted Answer

A)  a change in relative tax rates 
B)  a change in relative depreciation rates 
C)  a change in relative prices 
D)  a change in relative marginal productivity

Question 15

An increase in housing prices in Canada will likely have stronger effect on the aggregate consumption than a similar increase in the stock prices, because

Accepted Answer

A)  there are more Canadian stockholders than Canadian homeowners. 
B)  stock prices are far more volatile than the housing prices. 
C)  changes in stock prices are seen as permanent changes in wealth. 
D)  housing prices are more volatile than the stock prices.

Question 16

When a person gets an increase in current income, what is likely to happen to consumption and saving?

Accepted Answer

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 17

Suppose you divide your life into two periods-working age and retirement age. When you work, you earn labour income Y; when retired, you earn no labour 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?

Accepted Answer

The answer of Suppose you divide your life into two...

Question 18

The housing price in Canada nearly doubled in the period 1995-2006. This implies that

Accepted Answer

A)  Canadian homeowners income has increased, leading to more consumption. 
B)  Canadian homeowners wealth has increased, leading to more consumption. 
C)  Canadian homeowners wealth has decreased, leading to lower consumption. 
D)  Canadian homeowners income has decreased, leading to less consumption.

Question 19

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

Accepted Answer

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

Question 20

You are trying to figure out how much capacity to add to your factory. You will increase capacity as long as

Accepted Answer

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

Exam 4: Consumption, Saving, and Investment