Deck 14: Consumption and saving

Question 1

According to the permanent-income theory, if individuals A and B have the same average annual income but A's income fluctuates greatly from year to year while B receives an almost even flow of income each year, then

A)A will spend less than B out of permanent income
B)B will spend less than A out of permanent income
C)A will weigh current income less heavily in making consumption decisions than B
D)B will weigh current income less heavily in making consumption decisions than A
E)A's consumption will always be less than B's

Answer 1

A will weigh current income less heavily in making consumption decisions than B

Question 2

The permanent-income theory of consumption implies that

A)the short-run multiplier is smaller than the long-run multiplier
B)the short-run multiplier is larger than the long-run multiplier
C)the short-run multiplier is identical to the long-run multiplier
D)the long-run multiplier is equal to 1
E)the short-run multiplier is less than 1

Answer 2

the short-run multiplier is smaller than the long-run multiplier

Question 3

Consumption is an important element of aggregate demand because it

A)is the most volatile component of GDP
B)accounts for roughly 70 percent of GDP
C)is very interest sensitive
D)is greatly affected by stock market activity
E)all of the above

Answer 3

accounts for roughly 70 percent of GDP

Question 4

Assume a worker at age 25 with annual earnings of $45,000 who wants to retire at age 65 and expects to live until age 75.How much would the worker consume annually?

A)$40,000
B)$36,000
C)$32,000
D)$30,000
E)$28,000

Question 5

If we compare the life-cycle theory of consumption with the permanent-income theory we can conclude that they both

A)pay careful attention to microeconomic foundations
B)agree that temporary tax cuts can be used to stimulate the economy
C)have similar theoretical bases but disagree widely in their policy implications
D)explain why large changes in current income cause large changes in current consumption
E)none of the above

Question 6

The life-cycle theory of consumption implies that

A)the mpc out of wealth is very small
B)the mpc out of permanent income is larger than the mpc out of transitory income
C)a large change in stock values can affect the economy, but the effect is fairly small
D)an individual's mpc out of permanent income changes with age
E)all of the above

Question 7

The permanent-income theory of consumption asserts that people prefer a stable level of consumption throughout their lives and

A)will forego temporary or transitory opportunities to obtain higher income and consumption
B)calculate their level of consumption from the information they have regarding their average expected lifetime income
C)will only change their consumption behavior significantly if there is a transitory change in their income
D)this implies that the short-run mpc is greater than the long-run mpc
E)therefore always save the same fraction of their current income

Question 8

The debate about different consumption theories can be viewed as a debate over whether

A)the consumption of durable or non-durable goods should be considered
B)random events that can change consumption behavior really do occur
C)liquidity constraints do ever exist
D)the marginal propensity to consume is large or small
E)the average propensity to consume is less or greater than 1

Question 9

If you are age 20, have no accumulated wealth, and have an expected average annual income of $36,000, how much should you consume each year if you want to retire at age 65 and expect to live until age 80? You desire to leave no estate and to consume an equal amount in each of the next 60 years.

A)$36,000
B)$31,000
C)$27,000
D)$22,000
E)$20,000

Question 10

When the aggregate consumption function is defined as C = C? + cYD, then

A)the mpc increases with higher levels of disposable income
B)the mpc is constant at all levels of disposable income
C)the apc is constant at all levels of disposable income
D)the apc increases with higher levels of disposable income
E)the expenditure multiplier is less than one

Question 11

According to the life-cycle theory of consumption, what should have occurred after the stock market crash of 1987?

A)a decrease in current consumption
B)no change in current consumption since only nominal wealth was lost
C)no change in aggregate consumption since most people do not invest in the stock market
D)an increase in consumption since people were afraid to save
E)both B and C

Question 12

The long-run marginal propensity to consume (mpc) is

A) larger than the short-run mpc
B) slightly smaller than the short-run mpc
C) about half the size of the short-run mpc
D) identical to the short-run mpc
E) always equal to 1

Question 13

The life-cycle theory of consumption can be summarized as follows:

A)retired people need less so they can save more than working people
B)people want instant gratification and seldom worry about the future
C)people always tend to consume almost all of their current income
D)people plan their consumption and saving patterns to optimize the lifetime benefit from their disposable income
E)people adjust their current consumption constantly to keep a stable saving pattern over their lifetime

Question 14

According to the life-cycle theory of consumption, an individual's

A)mpc out of wealth is fairly large
B)mpc out of labor income increases with increasing age, until it becomes zero at retirement age
C)mpc out of transitory income is fairly small
D)level of consumption will decrease if his/her retirement age is increased
E)none of the above

Question 15

According to the permanent-income theory of consumption, a person whose income fluctuates widely from year to year will have

A)a higher apc in high-income years than in low-income years
B)a lower apc in high-income years than in low-income years
C)a consistently high apc year after year
D)a consistently low apc year after year
E)an apc that is equal to 1

Question 16

The life-cycle theory of consumption was first advanced by

A)James Duesenberry
B)Milton Friedman
C)Robert Hall
D)John Maynard Keynes
E)Franco Modigliani

Question 17

According to the permanent-income theory

A)increases in current income lead to proportionate increases in consumption and saving
B)a rise in income affects consumption only after a delay of several years
C)a person's consumption in any given year will be strongly affected by interest rate changes
D)a person's consumption in any year will always be closely tied to his/her highest previous level of consumption
E)none of the above

Question 18

Which of the following theories of consumption behavior was introduced by Milton Friedman?

A)the absolute-income hypothesis
B)the relative-income hypothesis
C)the permanent-income hypothesis
D)the life-cycle hypothesis
E)the random-walk hypothesis

Question 19

According to the simplified life-cycle theory of consumption, a retired person with zero income from labor would

A)only consume the interest on accumulated wealth
B)consume a fraction of accumulated wealth based upon her/his life expectancy
C)have to decrease consumption sharply in order not to run out of funds too soon
D)expect to be financially supported by her/his children
E)consume more than during her/his working years since she/he does not expect to live much longer

Question 20

In 1968, President Johnson and Congress implemented a temporary surcharge on personal and corporate income taxes.What was the effect of this?

A)economic activity declined sharply and the economy entered a recession
B) consumption and investment spending declined significantly
C) households decreased their savings and aggregate demand was hardly affected at all
D)consumption and saving declined, while investment was not affected
E)both A and B

Question 21

The sensitivity of current consumption to changes in current income can be explained by

A)myopia
B)the absence of liquidity constraints
C)the fact that consumers have the opportunity to borrow
D)the fact that consumers always realize when a permanent change in income has occurred
E)none of the above

Question 22

Liquidity constraints explain

A)why consumers may spend less than the permanent-income theory predicts as their current income falls
B)why consumption may increase more than the life-cycle hypothesis predicts when income recovers after a recession
C)why consumers may sometimes behave in a manner predicted by the simple Keynesian consumption function
D)all of the above
E)none of the above

Question 23

Buffer-stock saving

A)is consistent with the life-cycle hypothesis if uncertainty about future needs is included
B)disproves the life-cycle hypothesis
C)is the result of a permanent increase in income that is not immediately consumed
D)explains the wealth effect
E)none of the above

Question 24

A temporary tax change will significantly affect current consumption

A)but only if it does not come as a surprise
B)if liquidity constraints exist
C)but only for the elderly
D)as long as it does not lead to a budget deficit
E)none of the above

Question 25

According to the permanent-income theory of consumption

A)permanent income is always lower than transitory income
B)the mpc out permanent income is close to zero
C)the mpc out of transitory income is close to 1
D)all of the above
E)none of the above

Question 26

If a worker gets a large one-time Christmas bonus, most likely the following will occur:

A)an immediate substantial increase in family consumption
B)permanent family income will increase substantially
C)transitory family income will not be affected
D)family saving will increase that year
E)all of the above

Question 27

The random-walk theory of consumption asserts that changes in consumption arise from unexpected changes in income.This approach

A)clearly contradicts Modigliani's theory
B)clearly contradicts Friedman's theory
C)contradicts Modigliani's theory but supports Friedman's theory
D)supports Modigliani's theory but contradicts Friedman's theory
E)supports Modigliani's and Friedman's theories

Question 28

The theory of consumption of durable goods

A)is basically a theory of investment applied to households
B)states that durable goods purchases are very insensitive to interest rate changes
C)can be explained very well by the life-cycle theory, since people spread their durable goods purchases equally over their lifetimes
D)suggests that expenditures on durable goods do not increase utility as much as expenditures on other consumption goods
E)none of the above

Question 29

Assume you unexpectedly inherit $20,000.Which of the following fits the life-cycle or permanent-income theory of consumption?

A)you buy yourself some blue chip stocks
B)you pay back part of your student loan
C)you spend $600 on a new laptop computer and use the rest to buy government bonds
D)you deposit $1,000 in your checking account and $19,000 in your savings account
E)all of the above

Question 30

Empirical studies of aggregate consumption have shown that

A)100% of the variation in consumption can be explained by changes in current income
B)wealth effects generally account for only a small amount of consumer expenditures
C)wealth effects generally are very large, which explains the large variations in consumption from year to year
D)changes in wealth have a bigger impact on consumption than changes in income
E)the marginal propensity to consume out of wealth is close to one

Question 31

Robert E.Hall's theory of consumption behavior is called

A)the absolute-income hypothesis
B)the permanent-income theory
C)the random-walk theory
D)the buffer-stock theory
E)the life-cycle theory

Question 32

If uncertainty about future income and future needs is incorporated into the life-cycle theory of consumption, then

A)buffer-stock saving can no longer be explained
B)the fact that consumption is interest sensitive can be explained
C)the fact that people rarely use up their lifetime saving can be explained
D)the fact that saving is interest sensitive can be explained
E)it is significantly different from the permanent-income theory

Question 33

What does the permanent-income theory of consumption predict you would most likely do with $25,000 that you just won on a TV game show?

A)travel throughout Europe and eat in five-star restaurants
B)invite all your friends to a big bash
C)put the money in the bank to finance your next year in college
D)take a trip to Las Vegas to try and double your winnings
E)none of the above

Question 34

Assume you define your permanent income as the average of your income over the most recent five years, and you always consume 90% of your permanent income.What is your current consumption if your income was $30,000 in the first of these five years and each year from then on you got a raise of $2,000?

A)$36,000
B)$34,200
C)$30,600
D)$28,800
E)$27,000

Question 35

The fact that consumption exhibits "excess sensitivity" implies that consumption

A)responds too strongly to predictable changes in income
B)responds too little to predictable changes in income
C)responds too little to surprise changes in income
D)is never affected by liquidity constraints
E)never behaves as Keynes predicted

Question 36

The random-walk theory of consumption predicts that

A)the slope of a line relating C(t+1)to C(t)is equal to 1
B)the slope of a line relating C(t+1) to C(t) is equal to 0
C)the slope of a line relating C(t+1) to C(t) is close to 0
D)the slope of a line relating C(t)to Y(t)is close to 1
E)none of the above

Question 37

Hall's random walk-theory of consumption states that consumption tomorrow should equal

A)income tomorrow minus income today plus some random error
B)income today minus consumption today plus some random error
C)consumption today plus some random error
D)permanent income plus some random error
E)income tomorrow plus some random error

Question 38

According to the permanent-income theory, which of the following would have the greatest impact on the current consumption of a 45 year-old tenured college professor?

A)a promotion to full professor combined with a $5,000 raise
B)a $5,100 advance payment for a book that will take two years to write
C)winning $5,200 in the Reader's Digest Sweepstakes
D)a loss of a stamp collection worth $5,400
E)an inheritance of $5,500 from a distant uncle

Question 39

Actual consumption behavior exhibits both "excess smoothness" and "excess sensitivity," which means that

A)consumption responds too strongly to surprise changes in income
B)consumption responds too little to predictable changes in income
C)consumption always follows a random walk
D)consumption always adjusts with long lags
E)none of the above

Question 40

The sensitivity of current consumption to changes in current income arises from

A)liquidity constraints
B)the close relation between current consumption and permanent income
C)income changes that tend to be mostly random and unpredictable
D)the close relation between current and lagged consumption
E)none of the above

Question 41

When examining the impact of changes in the interest rate on saving, which of the following is true?

A)higher interest rates may make saving more attractive
B)higher interest rates allow individuals to save less each year to reach their retirement saving goal
C)empirical evidence does not suggest that interest rate changes significantly affect saving
D)all of the above
E)none of the above

Question 42

The Barro-Ricardo equivalence proposition implies that tax cuts

A)always lead to a reduction in the budget deficit
B)always lead to the crowding out of investment spending
C)that lead to higher budget deficits do not stimulate consumption since people will save in anticipation of future tax increases
D)provide important incentives for economic growth
E)ease people's liquidity constraints so they consume more

Question 43

The proposition that financing debt by issuing bonds merely postpones taxation and is therefore in many instances equivalent to current taxation is known as the

A)balanced budget theorem
B)rational expectations proposition
C)Barro-Ricardo equivalence proposition
D)Reagan theory of taxation
E)none of the above

Question 44

Assume the government announces an income tax surcharge of 10% for next year only and the Fed announces that it will keep interest rates constant.What effect do you think this will have on the economy?

A)households will immediately curtail their spending and aggregate demand will decline significantly, causing a recession
B)households will reduce their spending significantly starting next year
C)households will not significantly alter their spending behavior this or next year and the effect on the economy will be minimal
D)households will spend a lot more this year, causing a temporary boom
E)households will save a lot more this year so they won't have to reduce their spending next year

Question 45

If the interest rate increases,

A)consumption of non-durable goods will decrease substantially
B)saving will increase substantially
C) consumption of durable goods will increase substantially
D)both B and C
E)none of the above

Question 46

There is empirical evidence for the fact that

A)an increase in interest rates significantly reduces the level of consumption of non-durable goods
B)an increase in wealth has no effect on the level of consumption
C)the effects of interest rate changes on saving are small and hard to determine
D)an increase in interest rates significantly increases the level of saving
E)none of the above

Question 47

In the Fisher diagram, which gives a microeconomic explanation of why an increase in the rate of interest (i) can lead to either an increase or a decrease in current consumption, the budget constraint can be formulated as

A)
B)
C)
D)
E)

Question 48

The Barro-Ricardo equivalence proposition relies on

A)the presence of an operational bequest motive
B) the absence of liquidity constraints
C) the presence of liquidity constraints
D)both A and B
E)both A and C

Question 49

Any policy designed to increase business saving will most likely

A)not affect national saving since personal saving will decline proportionally
B)not affect national saving since the resulting budget deficit will reduce government saving
C)increase national saving since personal saving will decrease by less than the increase in business saving
D)reduce national saving since personal saving will decrease by more than the increase in business saving
E)reduce national saving due to the decline in personal and government saving

Question 50

The Barro-Ricardo equivalence proposition

A)states that debt-financing merely postpones taxation and therefore in many instances is equivalent to current taxation
B)relies on the absence of liquidity constraints and the presence of an operational bequest motive
C)implies that a cut in current taxes that carries with it an implied increase in future taxes will lead to an increase in private saving
D)was not supported by events of the 1980s as taxes were cut, budget deficits increased, and private saving declined
E)all of the above