Chapter 4: Consumption, saving, and investment
Desired capital stock equation
K^d=MPK^f = uc
Fiscal Policy
affects C^d through changes in current and expected future income
depreciation
allowances reduce the tax paid by firms because they reduce profits
effect of changes in current income decrease in current income
both consumption and saving decrease
effect of changes in current income increase in current income
both consumption and saving increase
Desired capital stock depends on
costs and benefits of additional capital
fiscal policy
directly affects desired national saving
net investment
gross investment (I) mins depreciation
gross investment
new capital increases the capital stock
an increase in t raises the tax-adjusted user cost and ______ the desired capital stock
reduces
future marginal product of capital (MPK^f)
the benefit of investment
What is the effect on desired consumption and desired national saving of a lump-sum tax increase? Assume that Ricardian equivalence holds. Desired Consumption, C^d _____ Desired National Saving, S^d _____
unchanged; unchanged
The application implies that ▼ younger older people are more likely to have binding borrowing constraints and therefore that they are likely to spend ▼ more less of a tax rebate than other groups.
younger; more
Which of the following would cause a bond to have a relatively high interest rate? (Select all that apply) A. A bond that has a long maturity. B. There is a high probability that the firm issuing the bond will go out of business. C. A bond that has high default risk. D. The bond being a U.S. Treasury bill.
A. A bond that has a long maturity. B. There is a high probability that the firm issuing the bond will go out of business. C. A bond that has high default risk.
The application discusses a 1994 study by Cummins, Hubbard, and Hassett. Which of the following would seriously undermine the assumptions of this study? A. Evidence that changes in investment during periods of large tax changes are attributable to some non-tax factor. B. Evidence that tax laws are different for different types of capital. C. Evidence that any factors other than tax laws changed during the periods studied. D. All of the above.
A. Evidence that changes in investment during periods of large tax changes are attributable to some non-tax factor
What are the two components of the user cost of capital? A. The real interest rate and the rate of depreciation. B. The price of a unit of capital and the rate of inflation C. The real interest rate and salvage cost. D. The rate of depreciation and salvage cost.
A. The real interest rate and the rate of depreciation.
In this question, you will describe how the average household changed its pattern of credit-card payments, spending, and debt over time after receiving its tax rebate in 2001. When households first received their tax rebates, on average they A. did not increase spending on their credit cards and reduced their credit-card debt. B. increased spending on their credit cards and increased their credit-card debt. C. increased spending on their credit cards and reduced their credit-card debt. D. did not increase spending on their credit cards and increased their credit-card debt.
A. did not increase spending on their credit cards and reduced their credit-card debt.
What is the desired capital stock? A. The desired capital stock is the difference between gross investment and net investment. B. The desired capital stock is the amount of capital that exactly replaces worn out capital. C. The desired capital stock is the amount of capital that allows the firm to earn the largest possible profit. D. The desired capital stock is defined where the marginal productivity of capital equals zero.
C. The desired capital stock is the amount of capital that allows the firm to earn the largest possible profit.
Which of the following statements best summarizes the behavior of the Thomson Reuters/University of Michigan Index of Consumer Sentiment as related to a recession? A. The index exhibits sharp downturns that begin months before recessions occur, providing economists and politicians with reliable warnings of recessions to come. B. The index remains roughly constant over time regardless of what is going on in terms of a recession or expansion in the economy as a whole. C. The index tends to turn down sharply during recessions, but there are also significant turndowns when no recession exists. D. The index turns down sharply during an economic expansion and turns up sharply during an economic recession—the opposite of initial economic expectations.
C. The index tends to turn down sharply during recessions, but there are also significant turndowns when no recession exists.
The yield curve slopes upward. Which of the following best explains this observation? A. Treasury bonds and municipal bonds have about the same amount of default risk. B. The interest rate on a municipal bond tends to be higher than the interest rate on a Treasury bill. C. The interest rate on a bond with a 30-year maturity tends to be higher than the interest rate on a bond with a 10-year maturity. D. There are many interest rates in the economy, but they all tend to rise and fall together.
C. The interest rate on a bond with a 30-year maturity tends to be higher than the interest rate on a bond with a 10-year maturity.
What is the basic motivation for saving? A. To maximize the returns from saving. B. To maximize current consumption. C. To provide for future consumption. D. To reduce tax obligations.
C. To provide for future consumption.
Give two equivalent ways of describing equilibrium in the goods market. A. Y = Cd + Id and Sd = Y−Id B. Y = Cd + Sd + G and Sd = Id+(G−T) C. Y = Cd + Id + G and Sd = Id D. Y = Cd+Id+G−T and Sd = Id−G
C. Y = Cd + Id + G and Sd = Id
Evidence suggests that the 2001 tax rebates were A. almost entirely saved by consumers. B. initially spent by consumers who later increased their saving. C. initially saved by consumers who later increased their spending. D. almost entirely spent by consumers.
C. initially saved by consumers who later increased their spending.
The study by Croushore cited in the application indicates that the best models to predict future consumer spending would include information on A. stock prices and consumer sentiment, but not necessarily interest rates. B. consumer sentiment and interest rates, but not necessarily consumer income. C. past consumer spending and stock prices, but not necessarily consumer sentiment. D. consumer knowledge of monetary and fiscal policy, but not necessarily past consumer spending.
C. past consumer spending and stock prices, but not necessarily consumer sentiment.
_____ declines less than G rises, _____ declines
C^d; S^d
effect of changes in current income aggregate level: when current income (Y) rises, then ____ rises, but not as much as Y so _____ rises
C^d; S^d
Why might low taxes be associated with a decrease in investment? A. A decrease in taxes tends to lower the interest rate and therefore investment spending. B. Congress decreases taxes to lower investment in contractionary fiscal policy. C. Congress decreases taxes to lower investment in expansionary fiscal policy. D. Congress might lower taxes as a response to already-low investment spending.
D. Congress might lower taxes as a response to already-low investment spending.
Which of the following is an example of a time period in the United States when changes in consumer sentiment were not met with changes in consumption spending in the same direction? A. The recession between 1978 and 1980. B. Late 2007 to early 2008, when financial markets crashed. C. The period of large productivity gains in the United States in the mid-1990s. D. Late 1998, when the Russian government defaulted on a large amount of debt.
D. Late 1998, when the Russian government defaulted on a large amount of debt
Nine months after households received their tax rebates, on average they A.did not increase spending on their credit cards and reduced their credit-card debt. B.did not increase spending on their credit cards and increased their credit-card debt. C.increased spending on their credit cards and reduced their credit-card debt. D. increased spending on their credit cards and increased their credit-card debt.
D. increased spending on their credit cards and increased their credit-card debt.
Agarwal, Liu, and Souleles's study indicates that the Ricardian equivalence theory seems to hold A. more true for people with low credit limits than for people with high credit limits. B. true for neither those with high credit limits nor low credit limits. C. equally true for those with high credit limits and low credit limits. D. more true for people with high credit limits than for people with low credit limits.
D. more true for people with high credit limits than for people with low credit limits.
The study by Cummins, Hubbard, and Hassett implies that a decrease in taxes related to investment in factories A. would have no significant effect on investment for firms who already heavily invest in factories. B. could convince firms that currently heavily invest in machines to switch to investment in factories. C. would result in the same increase in investment regardless of whether a firm tends to invest in factories or machines. D. would result in the biggest increase in investment for firms who already heavily invest in factories.
D. would result in the biggest increase in investment for firms who already heavily invest in factories.
What effect does a temporary increase in government purchases -- for example, to fight a war -- have on desired consumption and desired national saving, for a constant level of output? Assume that Ricardian equivalence holds. Desired Consumption, C^d _____ Desired National Saving, S^d _____
Decrease (↓);Decrease (↓)
Real Interest Rate (↑): desired saving (lender) S^d Substitution effect _____ income effect _____ total (net) effect _____
Increase (↑); Decrease (↓); Ambiguous ?
Real Interest Rate (↑): desired saving (borrower) S^d Substitution effect _____ income effect _____ total (net) effect _____
Increase (↑); Increase (↑); Increase (↑)
net investment equation
Kt-1 - K = It - dKt
For a household with a given level of income, how are consumption and saving linked?
Saving = Income - Consumption
A country loses much of its capital stock to a war. What effects should this event have on the country's current employment, output, and real wage? This event should cause the country's current employment _____ output to _____ and the real wage _____
decrease (↓); decrease (↓); decrease (↓)
Government purchases (G) ______ both C^d and S^d
decreases
A country loses much of its capital stock to a war. What effects should this event have on the country's current employment, output, and real wage? The loss of capital will cause desired investment to _____
increase (↑)
Assume that the desired saving function doesn't change. The loss of capital will cause the country's real interest rate and the quantity of investment to_____
increase (↑)
a tax cut today leads to ______ C^d and ____ S^d
increased; decreased
How are desired consumption and desired saving affected by increases in current income, expected future income, and wealth? When expected future income rises, desired consumption______ and desired saving_____
increases (↑); decreases (↓)
How are desired consumption and desired saving affected by increases in current income, expected future income, and wealth? When wealth rises, desired consumption_____ and desired saving _____
increases (↑); decreases (↓)
How are desired consumption and desired saving affected by increases in current income, expected future income, and wealth? When current income rises, desired consumption _____ and desired saving increases _____
increases (↑); increases (↑);
Compared to earlier research, later research indicates that a ▼ larger smaller amount of the 2001 tax rebates was spent than originallythought, implying that the rebates did a ▼ better worse job of stimulating the economy than originally thought.
larger; better
Ricardian equivalence proposition- If future income loss exactly offsets current income gain ______ in consumption
no change
The basic rate that banks charge on loans to their best customers is called the ▼ federal funds rate prime rate default risk free rate , the interest rate on a Treasury bond is called the ▼ default risk free rate federal funds rate prime rate and the interest rate on overnight loans between banks is called the ▼ default risk free rate federal funds rate prime rate .
prime rate; default risk free rate; federal funds rate
_____ are taxed
profits
user cost of capital
real cost of using a unit of capital for a specified period of time = real interest cost + depreciation
Higher G financed by higher future taxes _____
reduces after-tax income and lowering C^d
Higher G financed by higher current taxes _____
reduces after-tax income, and lowering C^d
capital stock depreciates
reduces the capital stock
desired capital stock
the amount of capital that allows the firm to earn the largest expected profit
consumption-smoothing motive
the desire to have a relatively even pattern of consumption over time
n general, the prime interest rate and the federal funds rate tend to move in ▼ opposite the same direction.
the same
effective tax rate (ETR)
the tax rate on firm revenue that would have the same effect on the desired capital stock as do the actual provisions of the tax code
user cost of capital equation
uc = rpK + dpK = (r+d)pK
The application indicates that the Thomson Reuters/University of Michigan Index of Consumer Sentiment is ▼ useful not useful as a way to measure consumer perceptions about the current economy, ▼ useful not useful as a tool to help explain past changes in spending, ▼ useful not useful as a way to measure consumer perceptions about likely future changes in the economy, and ▼ useful not useful as a method of forecasting consumer spending.
useful; useful; useful; useful