Econ 303 Exam 3

Long term capital gain and dividend are taxed at a lower marginal tax rate

due to a double taxation problem.

On a loanable funds market when real interest rate increases

the quantity of funds supplied by households increases.

If the marginal rate of substitution between c2 and c1 is less than the inverse of (1+r),

marginal benefit of increasing c2 a bit is less than its marginal cost and a bit less saving improves happiness.

A decrease in the real interest rate will lead to a substitution effect described by which of the following statements?

Consumption in the future is relatively more expensive; households consume more now and less in the future.

Which of the following statements is correct?

Consumption tax has substitution effect and income effect in consumption-leisure choice but only has income effect in intertemporal choice.

John's $6,000 deposit in a CD account has an interest rate of 4.6%. John's marginal tax rate is 15% when filing for federal personal income tax. How much revenue does the government collect from John's interest income?

$41.4

Dan's income now is $83,000 and his income in the future will be $100,000. The real interest rate is 5%. Which of the following consumption bundle is feasible for Dan?

(90,000, 92,000)

Suppose that the real interest rate is r. To get one unit of real income next period how much does a household has to save today?

1/(1+r)

Dick became a partner of a consulting firm. He bought the lifetime membership of a country club. Dick's behavior can be explained by which of the following?

A permanent increase of income.

Adam's marginal rate of substitution between c2 and c1 is 1.2. Which of the following statement is true?

Adam is willing to buy one unit of c2 with 1.2 units of c1.

Amy's life time utility is ln c1 + 0.95 ln c2. In a consumption bundle, the first number indicates the amount of consumption today and the second the amount of consumption tomorrow. Which of the following statements is true?

Amy prefers bundle (92, 92) over bundle (88, 95)

There are policy proposals to move the US tax system from income based to consumption based. What is the theoretical support to such reform initiatives?

Both consumption and income tax distort households' labor supply decision, but income tax also distorts households' saving decision while consumption tax does not.

Which of the following statements is correct regarding to capital income tax?

Capital income tax has both income and substitution effect in household intertemporal choice. Theoretically capital income tax to a borrower is a subsidy. Capital income tax effectively reduces the real interest rate making current consumption relatively cheaper.

Which of the following arguments is the correct reason for eliminating capital income tax?

Capital income tax lowers the after tax return on households' saving, hence reduces saving and investment.

Consumption smoothing refers to

Consumers choosing a consumption path that is smoother than income

We assume that the representative household's preferences exhibits all of the following properties, EXCEPT which one?

Current and future consumption must be the same.

Edward is 60 years old. He had accumulated a sizable retirement fund invested in the stock market. Michael is 25 year old. He just started to accumulate his retirement fund. When returns on the stock market increases which of the following is a correct statement?

Edward is affected mainly through income effect while Michael is affected mainly through substitution effect.

Suppose that an economy lasts for two periods. The government spending of the two periods are 0.5 and 0.11, respectively. Suppose that the real interest rate is 10% and the amount of tax collected in the first period is 0.3. Which of the following is correct?

Government borrowing in the first period is 0.2.

Jake has a log utility and discounts future utility by a factor of 0.9. His consumption now is 95 units and consumption in the future is 88 units. Which of the following is correct?

He should save a bit more if the real interest rate is 4%.

Grant sold his holding of NVIDIA, a compute chip company, and made a lot of money. Which of the following statements is correct?

He works less due to an income effect and saves more due to an income effect.

In our model, households dislike variation of consumption. This aversion comes from which assumption on utility function?

Households have diminishing marginal utility of consumption.

Joe has a bigger subjective discount factor than Arthur. For example, Joe's subjective discount factor is 0.95 while Arthur's is 0.9. Which of the following is NOT correct?

If Joe and Arthur have the same income and interest rate Joe will consume more now than Arthur.

Which of the following is the tax base of a capital income tax?

Interest received by Mr. Sam on his saving account.

All of the following are consumption taxes EXCEPT which one?

Payroll tax

Lisa inherited some money from her grandma and Mary got her Master of Science degree in CS and was recruited by Google. In general,

Mary has a higher marginal propensity to consume out of her increased income than Lisa.

The marginal condition MRSc2,c1=1/(1+r) applies to which of the following scenarios?

Mr. Bricks decides how much to put in his 401(k), a tax deferred retirement saving program.

Jessie has a square root utility function with a subjective discount factor of 0.93. Her current consumption bundle is (c1=108, c2=94). Which of the following is NOT correct?

One more unit of consumption brings Jessie the same amount of additional happiness.

Contrary to the prediction of Ricardian equivalence studies on Bush 2008 tax rebate showed that a tax cut without cutting spending led to some increase of private consumption. In this case

Ricardian equivalence fails because some households are credit constrained; they would like to borrow to consume today but were discouraged by high interest rate they have to pay.

Which of the following is a tax free saving program?

Roth IRA

A tax reduction without a spending cut will cause households to do which of the following?

Save more and consume the same amount.

Mary won a $100,000 lottery. According to the Permanent Income Hypothesis (PIH), Mary will do which of the following?

Spend a small amount of the money right away and save the rest for future consumption.

Which of the following statements is correct?

Tax free saving could be equivalent to tax deferred saving and both are better than regular saving.

The Clinton administration lowered the tax rate on income from capital gains and the later Bush administration lowered the tax rate on dividend. These tax reforms are justified by which of the following arguments?

Tax on dividend and capital gains is a capital income tax and a reduction of its tax rate encourages saving and accumulation of capital.

Two households, A and B, have the following income over two periods. Household: Period 1 Period2 A 50000 30000 B 20000 60000 When interest rate decreases, which of the following statements on present value (PV) of income is correct?

The PVs of income for both households are higher, but the increase of household B's PV is bigger.

Which of the following best describes the logic of Ricardian equivalence?

The income effect of different tax plans is determined by the present value of government spending.

Let r denote the real interest rate. The horizontal axis is consumption in the future and vertical axis is consumption now. Which of the following statements about intertemporal budget line is correct?

The vertical intercept is the present value of income and the slope (absolute value) is 1/(1+r).

Both Tim and Rob work for the same insurance company for the same pay. This year Tim landed a big contract and got a hefty bonus. Rob took a two-month unpaid leave to take care of his sick mother. Which of the following is a correct description of their consumption and saving behavior?

Tim will increase his current consumption and saving.

The nominal interest rate stays the same, while the inflation rate is higher. In this case,

a borrower experiences a positive income effect and is better off; a lender experiences a negative income effect and is worse off.

A wealth tax, whether levied while the owner is alive (proposal by Warren) or dead (federal estate and gift tax) is

a capital income tax with a tax rate more than 100%.

A positive capital income tax is equivalent to

a lower interest rate and could have positive or negative income effect on households.

A temporary increase in income today leads to

a small increase in current consumption; the marginal propensity to consume is small.

An increase in second-period income results in

an increase in first-period consumption, an increase in second-period consumption, and a decrease in saving.

If government spending is held constant and Ricardian equivalence holds

an increase in government saving is always matched by an equal reduction in private saving.

Capital income tax is considered as a bad tax because

capital income tax makes future consumption relatively more expensive hence reduces households' saving.

Corporate income tax is a

capital income tax.

If current income increases as much as future income decreases and the real interest rate is zero,

current consumption increases. current consumption stays the same.

The marginal propensity to consume measures how much does current consumption change when

current income changes.

Ricardian equivalence may fail if

government debt incurred today may not be paid off until after some current households are deceased.

For a lender a decrease in the real interest rate

has an uncertain effect on current consumption and decreases future consumption.

In the household saving decision, a capital income tax

has both a substitution effect and an income effect.

Mr. Green uses tax free saving plan instead of deferred tax saving plan because

he predicts that his marginal income tax rate when he retires would be higher than his marginal income tax rate now.

The supply curve on the loanable funds market is positively sloped if the representative household is a

lender and the substitution effect of an interest rate change dominates its income effect.

A constant income tax effectively

lowers the real wage and the real interest rate.

The real interest rate is 5%. On the market,

one unit of consumption today can purchase 1.05 unit of consumption tomorrow.

A consumer is a lender if

optimum current consumption is less than current disposable income.

If government runs fiscal deficit in a closed economy

public saving is negative and national saving is less than private saving.

An increase of future income

raises the present value of lifetime resources and has a positive income effect.

An increase of fiscal deficit will

shift the supply of funds to the private sector to the left. If nothing else happens, real interest rate goes up and private investment is reduced.

An increase in the real interest rate is an example of a

substitution effect and an income effect whose sign depends on whether the consumer is initially a borrower or a lender.

It is not optimal to restrict the government to balance the budget period by period, because

taxes collected by the government have substitution effects in addition to income effect; additional flexibility can help to reduce welfare cost of taxation.

If a household borrows at an interest rate greater than the interest rate at which he or she can lend

the budget constraint has a kink at the income point.

When the nominal interest rate is positive but less than the inflation rate

the dollar amount of saving increases next period, but the purchase power of saving decreases.

Draw a Lorenz curve based on data on household consumption distribution. The further away is the Lorenz curve from the diagonal line,

the more unequal is the distribution of consumption.

When the real interest rate falls,

the present value of income is larger. the opportunity cost of consuming now is smaller. consumption in the future is more expensive.

We say a tax plan is feasible as long as

the present value of tax collections is greater than or equal to the present value of government spending.

On the loanable funds market things traded are

the right to use a certain amount of money; price is usage fee, aka, the real interest rate.

In a crude oil producing country a recent surge of international oil price increases the income of average households. On the loanable funds market

the supply curve shifts to the right and the real interest rate decreases.

Experts recommend the young adult to use tax free saving program instead of tax deferred saving program if they are interested in saving for retirement, because

their marginal tax rate is in general very low now.

On the loanable funds market the demand is downward sloping, because

when real interest rate goes up, firms want to borrow less. of the law of diminishing marginal product of capital. firms are profit maximizers; only investment with higher returns than real interest rate are financed.