Chapter 4: Consumption, saving, and investment

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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 originally​thought, 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


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