Question 1

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

Accepted Answer

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. A

Question 2

What is the impact on current consumption of a temporary tax cut according to: a. the Keynesian consumption functi on?
b. the permanent-income hyp othesis?

Accepted Answer

a. In the Keynesian consumption function, the temporary tax cut increases disposable income and consumption increases by the $M P C$ times the change in disposable income.
b. According to the permanent-income hyp othesis, the additional income avalable as a result of the temporary tax cut would be spread over the remaining lifetime, so the increase in current consumption would be only a tiny fraction of the increase in income.

Question 3

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

Accepted Answer

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. B

Question 4

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

Accepted Answer

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 5

If a consumer is a borrower in period one and the interest rate rises, the:

Accepted Answer

A)   income and substitution effects both tend to make consumption higher in the first period.
B)   income and substitution effects both tend to make consumption lower in the first period.
C)   income effect tends to make consumption higher in the first period and the substitution effect tends to make it lower.
D)   substitution effect tends to make consumption higher in the first period and the income effect tends to make it lower.

Question 6

If consumers want consumption to be as constant as possible over their life cycles and income rises gradually over their periods of employment, then if borrowing constraints prevent their wealth from falling below zero:

Accepted Answer

A)   they can achieve constant consumption by borrowing.
B)   their consumption in retirement will be higher than it was in earlier parts of the life cycle.
C)   their consumption during their younger years will be lower than it will be in later parts of the life cycle.
D)   their consumption during their later working years will be higher than it was or will be in other parts of the life cycle.

Question 7

Recent work on the consumption function suggests that consumption depends on:

Accepted Answer

A)   current income alone.
B)   current income and expected future income.
C)   current income, expected future income, and interest rates.
D)   current income, expected future income, interest rates, and wealth.

Question 8

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

Accepted Answer

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

Question 9

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

Accepted Answer

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

Question 10

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

Accepted Answer

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 11

The average propensity to consume is the:

Accepted Answer

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 12

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:

Accepted Answer

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

Question 13

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:

Accepted Answer

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 14

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:

Accepted Answer

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

Question 15

Assume that Andrew Marcus is 25 years old and expects to live to age 75. a. If he wins $\$ 20$ million in cash (after taxes) in the lottery and retires, how much will he consume each year if he wants to have constant consumption and use up all his wealth by the time he dies? Assume the real interest rate is zero.
b. If his total income in the year he wins the lottery is his lottery winnings, what will his average propensity to consume (APC) be for that year?
c. If he has no other earnings in later years but continues his constant consumption, what will his average propensity to consume be for those later years?
d. What is Andrew's "permanent income" in the year he wins the lottery? What is his "transitory income"?

Accepted Answer

The answer of Assume that Andrew Marcus is 25 years...

Question 16

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

Accepted Answer

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 17

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:

Accepted Answer

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

Question 18

Milton Friedman argued that, on average, consumption is:

Accepted Answer

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 19

Assume that Jeannie Drago is trying to allocate her consumption over two periods of life: work and retirement. Each period is to last 20 years. To simplify, assume that all income comes at time t₁ in the middle of 20 years of work, and all expenditures come at either t₁ or t₂, 20 years later. Jeannie's budget constraint is C₁ + C₂/(1 + r/100) = Y₁ + Y₂/(1 + r/100), where the real interest rate r is 100 percent (approximately 3.5 percent per year over 20 years). Jeannie's preferences are to have equal consumption each period. a. What are $C _ { 1 }$ and $C _ { 2 }$ if $Y _ { 1 } = 1$ million and $Y _ { 2 } = 0$ ? b. What are $C _ { 1 }$ and $C _ { 2 }$ if $Y _ { 1 } = 0$ and $Y _ { 2 } = 1$ million (reflecting, for example, an individual who plans to come into a large inheritance late in life)? Do these answers depend on Jeannie's being able to borrow against the inheritance?

Accepted Answer

The answer of Assume that Jeannie Drago is trying to...

Question 20

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

Accepted Answer

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

Exam 16: Understanding Consumer Behavior