Chapter 4

how much you have in nominal terms

beginning amount * (nominal after tax rate for each year invested + 1)

A permanent decline in the expected real interest rate has what effect on desired capital stock?

raises it, because the user cost of capital is now lower

desired national saving

Y-Cd-G

an increase in the expected real interest rate will

decrease the desired capital stock

Expected real after-tax interest rate

(1- income tax rate) (nominal interest rate) - (expected inflation rate)

demand for goods in a goods market equilibrium

Cd+Id+G

When a company must consider taxes in determining investment, its desired capital stock is chosen such that

MPKf=uc(1-t)

municipal bond

a bond issued by a state or local government =IR - expected inflation

indifference curve

a curve that connects all the consumption combination that yield the same level of utility

factors that rightward shift saving in saving investment graph

an increase in desired national saving can be caused by: -rise in current output -decrease in expected future output -decrease in wealth -Increase in expected real interest rate -decrease in gov purchases -Increase in taxes (can remain unchanged tho)

factors that rightward shift investment in saving investment graph

an increase in desired national saving that can be caused by: -decrease in real interest rate -decrease in tax rate -increase in expected future MPK

when a person receives an increase in wealth, what is likely to happen to consumption and saving?

consumption increases and saving decreases

the sub effect of a decrease in real interest rates is to cause a consumer to

decrease future consumption and increase current consumption

three factors that cause interest rate among different financial instruments to vary

default risk, maturity, and taxability

Goods market equilibrium

desired national saving = desired national investment (In a closed economy)

Cummins, Hubbard, and Hassett studied the effects of taxes on investment by

examining what happened to investment when major tax reforms took place. They found that investment responded to a tax change with an elasticity of -0.66

The desired level of the capital stock will increase if the

expected future marginal product of capital increases OR there is a decline in the user cost of capital

if consumers believe there will be a recession then real interest rate and investment...

falls and increases

net investment

gross investment - depreciation

a temporary supply shock, such as a one month decrease in oil prices, would

have little or no effect on desired investment

if the government provides a tax cut today that is matched by a tax increase in the future that's equal in present value to the tax cut, consumer saving will...

increase

a technological improvement will

increase the desired capital stock.

an increase in the price of capital goods will

increase the interest cost and the depreciation cost of capital

An increase in expected future output while holding today's output constant would

increase today's desired consumption and decrease desired national saving

what are the economic consequences of reductions in defense spending by the government? What happens to national saving, interest rate, and investment?

increases national saving so desired saving curve shifts to the right, meaning the real interest rate will decline and investment will increase.

the yield curve generally slops upward because

longer maturity bonds typically pay higher interest rates than shorter maturity bonds

For a borrower, an increase in the real interest rate will lead to

lower current consumption and less borrowing

a temp increase in gov purchases will do what to national saving and desired consumption?

lower desired national saving and desired consumption - (especially if taxpayers understand that more gov purchases means higher tax in the future, meaning household expected incomes will fall, increasing current saving)

the stock market just crashed; you would expect the effect on aggregate consumption to be the largest if which of the following was true?

many individuals had invested in the stock market immediately prior to the crash

when the real interest rate increases, what does this mean?

means each dollar of current saving will have a higher payoff in terms of increased future consumption - thus increasing current saving (unless the income effect is stronger, in which case it would decrease current saving and increase consumption)

if consumers force taxes completely, a reduction in taxes this year with an offsetting increase in future taxes would cause

no shift in saving or investment curves

how much you have in real terms

nominal amount/ (GDP deflator/base year)

real interest rate

nominal interest rate - inflation rate

if effective tax rate on capital is decreased, the real interest rate and saving...

rise, and increases

if the stock market booms then real interest rate and investment...

rises and declines

user cost of capital

rpk + dpk (stands for interest rate and depreciation rate)

nominal after tax rate of return

t bill (1 - tax rate)

marginal propensity to consume

the amount by which desired consumption rises when current income rises by one unit. It is always less than one because a part of any increase in current income is saved.

consumption-smoothing motive

the desire to have a relatively even pattern of consumption over time

You are trying to figure out how much capacity to add to your factory. You will increase capacity as long as

the expected marginal product of capital is greater than or equal to the user cost of capital

if a firm's expected marginal product of capital > tax adjusted user cost of capital

the firm will increase investment spending on capital goods

in forecasting consumer spending using surveys of consumer confidence, research suggests that...

the forecasts are NOT improved when using consumer confidence measures.

q theory

the relationship between stock prices and firm's investments in physical capital. It states that if q (representing the ratio of capital's market value to its replacement cost) is greater than one (q > 1), additional investment in the firm would make sense because the profits generated would exceed the cost of firm's assets. If q is less than one (q < 1), the firm would be better off selling its assets. q=V/(pK*K); V is stock market value, pK is price of capital, and K is quantity of capital.

Ricardian equivalence proposition

the result that a change in the timing of taxes does not affect people's consumption

when a person gets an increase in current income, what is likely to happen to consumption and saving?

they both increase

tax-adjusted user cost of capital

uc/(1-t)

how to find a firms optimal size of capital stock and what the graph looks like

uc=MPK; uc is a horizontal line and MPK is a downward sloping line. A decline in real interest rate increases optimal capital stock, thus increasing desired investment.

how to find a firms optimal amount of employment

w=MPN