Chapter 7 - Consumption, Saving and Investment

Name:

True/False
Indicate whether the statement is true or false.

If the value of initial assets increases, then a household will change consumption or present value of asset at the end of period 2 due to an income effect.

$100 a year from now is equal in worth to $100 today.

A discount factor is used to deflate nominal consumption to real consumption.

If wages rises by $10 per worker just this period, we would expect to see consumption rise by much less than $10 this period.

The aggregate household budget constraint is consumption plus net investment is real GDP less depreciation.

Multiple Choice
Identify the choice that best completes the statement or answers the question.

Real profit is zero when:

a.	the interest rate is zero.
b.	the depreciation rate is high.
c.	the labor and capital markets clear.
d.	the labor and capital markets do not clear.

When the labor and capital markets clear:

a.	depreciation is zero.
b.	real profit is zero.
c.	a dollar today is worth more than a dollar in the future.
d.	all of the above.

Real household saving is:

a.
b.
c.
d.

Real income is:

a.	wL + i(B+K)
b.	(w/P)L + i((B/P)+ K)
c.	(w/P)L + i((B/P)+(K/P))
d.	(w/P)L + i(B+ K)

	Figure 7.1

10.

In Figure 7.1 if the household opts to consume all its income it will be at point:

a.	F
b.	G
c.	H
d.	I

11.

In Figure 7.1 if the household decides to save all of its income, it would be at point:

a.	F
b.	G
c.	H
d.	I

12.

In Figure 7.1 if the household moves from point G to point H on its budget, it would be:

a.	saving and consuming more.
b.	saving less and consuming more.
c.	saving more and consuming less.
d.	saving and consuming less.

13.

In Figure 7.1 if the household moves from point I to point H on its budget, it would be:

a.	saving and consuming more.
b.	saving less and consuming more.
c.	saving more and consuming less.
d.	saving and consuming less.

14.

In Figure 7.1 if the household moves from point F to point H on its budget, it would be:

a.	saving and consuming more.
b.	saving less and consuming more.
c.	saving more and consuming less.
d.	saving and consuming less.

15.

In Figure 7.1 if the household moves from point H to point G on its budget, it would be:

a.	saving and consuming more.
b.	saving less and consuming more.
c.	saving more and consuming less.
d.	saving and consuming less.

16.

Real saving in year one is:

a.	real bonds plus capital in year 1 minus real bonds and capital in year 0.
b.	bonds plus capital plus money period 1.
c.	bonds plus capital in period 1.
d.	interest times the sum of bonds plus capital in period 1.

17.

The household’s year one budget constraint is:

a.	real assets at the end of year zero plus real income in year one less consumption in year one equals real assets at the end of year one.
b.	real income in year one less real assets at the end of year zero less consumption in year one equals real assets at the end of year one.
c.	real assets at the end of year zero plus real income in year one plus consumption in year one equals real assets at the end of year one.
d.	real income in year one plus consumption in year one less real assets at the end of year zero equals real assets at the end of year one.

18.

In the one period budget constraint sources of funds include:

a.	labor income.
b.	income from capital.
c.	income from bonds.
d.	all of the above.

19.

In the one period budget constraint sources of funds include:

a.	labor income.
b.	interests bearing money.
c.	capital gains.
d.	all of the above.

20.

In the one period budget constraint sources of funds include:

a.	capital gains.
b.	income from capital.
c.	income from rising prices.
d.	all of the above.

21.

In the one period budget constraint sources of funds include:

a.	capital gains.
b.	inflation.
c.	income from bonds.
d.	all of the above.

22.

In the one period budget constraint the uses of funds include:

a.	purchases of consumption goods.
b.	purchases of capital goods.
c.	purchases of bonds.
d.	all of the above.

23.

In the one period budget constraint the uses of funds include:

a.	purchases of consumption goods.
b.	payment of wages.
c.	payment profits.
d.	all of the above.

24.

In the one period budget constraint the uses of funds include:

a.	payment of transfers.
b.	purchases of capital goods.
c.	payment of wages.
d.	all of the above.

25.

In the one period budget constraint the uses of funds include:

a.	payment of transfers.
b.	payment of wages.
c.	purchases of bonds.
d.	all of the above.

26.

The measure used to reduce future consumption to today’s values is called:

a.	an implicit deflator.
b.	a discount factor.
c.	an escalator.
d.	a future value.

27.

When a discount factor is multiplied times a future period variable it creates a:

a.	future value.
b.	a present value.
c.	a real variable.
d.	a nominal variable.

28.

A dollar today is worth more than a dollar a year from now as long as:

a.	the interest rate is negative.
b.	the interest rate is positive.
c.	the depreciation rate is negative.
d.	the depreciation rate is positive.

29.

An income effect is the response of households to changes in the present value of:

a.	relative prices.
b.	sources of funds.
c.	uses of funds.
d.	assets at the end of year two.

30.

If the interest rate is greater than zero, then the concept of present value is that a dollar today:

a.	is worth more than a dollar a year from now.
b.	is worth less than a dollar a year from now.
c.	will be worthless a year from now.
d.	is worth the same as a year from now.

31.

If the present value of assets at the end of year two is constant, an increase in the present value of sources of funds must cause:

a.	consumption in periods one and two to rise.
b.	consumption in periods one and two to fall.
c.	consumption to rise in period one and fall in period two.
d.	consumption to fall in period one and rise in period two.

32.

The present value of sources of funds is:

a.	the value of initial assets plus the present value of wage income plus the present value of assets at the end of year two.
b.	the value of initial assets plus the present value of assets at the end of year two.
c.	the present value of wage income plus the present value of assets at the end of year two.
d.	the value of initial assets plus the present value of wage income.

33.

An increase in the interest rate:

a.	makes consumption in period two relatively more expensive compared to consumption in period one.
b.	does not change relative cost of consuming in either period.
c.	makes consumption in period two relatively cheaper compared consumption in period one.
d.	discourages savings in each period.

34.

If a household consumes one less unit in period 1, they can consume:

a.	on more unit in period two.
b.	(1 + i) more units in period two.
c.	one less unit in period two.
d.	no more in period two.

35.

Utility in economics is:

a.	a product with a derived demand like electricity.
b.	usefulness.
c.	satisfaction or happiness.
d.	all of the above.

36.

Utility in economics:

a.	used to mean happiness.
b.	used to mean satisfaction.
c.	is what a person gets from a good.
d.	all of the above.

37.

An increase in the interest rate can cause an income effect by:

a.	making future consumption cheaper.
b.	changing real income in year two.
c.	making present consumption cheaper.
d.	all of the above.

38.

An increase in the interest rate:

a.	makes future consumption cheaper.
b.	increases future income.
c.	makes present consumption more expensive.
d.	all of the above.

39.

An increase in the interest rate:

a.	makes future consumption cheaper.
b.	decreases future income.
c.	makes present consumption cheaper.
d.	all of the above.

40.

An increase in the interest rate:

a.	makes future consumption more expensive.
b.	decreases future income.
c.	makes present consumption more expensive.
d.	all of the above.

41.

An increase in the interest rate:

a.	makes future consumption more expensive.
b.	increases future income.
c.	makes present consumption cheaper.
d.	all of the above.

42.

An intertemporal substitution effect is caused by a change in:

a.	a price from one period to another.
b.	wealth.
c.	income.
d.	all of the above.

43.

The marginal propensity to save out of a temporary change in income is approximately:

a.	1
b.	0.5
c.	0
d.	none of the above.

44.

The marginal propensity to save out of a permanent change in income is approximately:

a.	1
b.	0.5
c.	0
d.	none of the above.

45.

The marginal propensity to consume out of a permanent change in income is approximately:

a.	1
b.	0.5
c.	0
d.	none of the above.

46.

The marginal propensity to consume out of a temporary change in income is approximately:

a.	1
b.	0.5
c.	0
d.	none of the above.

47.

If a worker receives a one time bonus we would expect them to:

a.	save most of it.
b.	refuse it.
c.	consume most of it.
d.	consume half and save half of it.

48.

If a worker receives a bonus every Christmas, we would expect them to:

a.	save most of it.
b.	reject it.
c.	consume most of it.
d.	consume half of it and save half of it.

49.

If a person wins $500 in a scratch-off lottery game, we would expect them to:

a.	save most of it.
b.	refuse it.
c.	consume most of it.
d.	consume half and save half of it.

50.

If a worker gets a promotion that doubles their salary, with the increase in salary we would expect them to:

a.	save most of it.
b.	reject it.
c.	consume most of it.
d.	consume half of it and save half of it.

51.

If the household budget constraint is aggregated over all household, it shows that:

a.	consumption plus net investment equal net national product.
b.	consumption plus net investment equals real GDP less depreciation.
c.
d.	all of the above.

52.

If the household budget constraint is aggregated over all household, it shows that:

a.	consumption plus net investment equal net national product.
b.	consumption less net investment equals real GDP less depreciation.
c.	.
d.	all of the above.

53.

If the household budget constraint is aggregated over all household, it shows that:

a.	consumption less net investment equal net national product.
b.	consumption plus net investment equals real GDP less depreciation.
c.
d.	all of the above.

54.

If the household budget constraint is aggregated over all household, it shows that:

a.	profit is zero.
b.	,
c.
d.	all of the above.

55.

In the multi-year budget constraint the present value of consumption equals the value of initial assets plus the:

a.	present value of savings.
b.	present value of final assets.
c.	present value of wage incomes.
d.	the present value of time.

Short Answer

56.

Derive the household’s two period real budget constraint.

57.

What is an intertemporal substitution effect and what can cause one?

58.

What is an income effect and what can cause one?

59.

What are the effects of an increase in the interest rate on the choice of consumption over time?

60.

Show the relationship between the household budget constraint and net national product.