Ecof304L, Introduction To Macroeconomics, Summer 2008 Homework4

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					                Eco f304L, Introduction To Macroeconomics, Summer 2008
                                       Homework 4


1     Multiple Choice
1. Experience for the United States shows that
A. consumption and GDP grow at about the same rate over the long term with GDP being less volatile
over the short-term business cycle.
B. consumption grows slower than GDP over the long term with consumption being less volatile over
the short-term business cycle.
C. consumption grows faster than GDP over the long term with consumption being more volatile over
the short-term business cycle.
D. consumption and GDP grow at about the same rate over the long term with GDP being more volatile
over the short-term business cycle.
E. consumption grows faster than GDP over the long term with GDP being more volatile over the short-
term business cycle.

    2. Which of the following rankings accurately lists the major components of consumption expendi-
ture in terms of their volatility over the business cycle?
A. Nondurables durables services
B.Durables nondurables services
C.Durables services nondurables
D.Services durables nondurables
E.N ondurables services durables

    3. Real GDP in the United States
A. exceeds disposable personal income by 40 percent, because GDP includes taxes, retained earnings,
and depreciation expenditures that are not part of personal income.
B. falls short of disposable personal income by 40 percent, because personal income includes transfer
payments that are not directly linked to production.
C. almost exactly equals disposable personal income, because depreciation expenses are such a small
fraction of gross investment in most years.
D. exceeds disposable personal income by over 50 percent because of the size of the federal budget.
E. none of the above.

     4. One reason why consumption expenditure is less volatile than GDP is that
A. personal disposable income is more volatile than GDP.
B. personal disposable income is less volatile than GDP.
C. the progressive income tax structure of the United States is too weak to generate higher and lower
collections during booms and recessions, respectively.
D. retained corporate earnings increase during recessions because firms use the slow times to retool for
the next upturn.
E. none of the above because the statement is false.
     5. The distinction between consumption and consumption expenditures, although subtle, becomes
important in the case of
A. services, since they are rapidly becoming a much larger portion of consumption.
B. nondurables, since they are becoming a much larger portion of consumption.
C. durables, since they are purchased erratically but consumed more or less continuously over time.
D. both a and b.
E. a, b, and c.

    6. The short-run marginal propensity to consume can be derived statistically by calculating how
A. the level of consumption responds to changes in the level of disposable income.
B. changes in consumption respond to changes in disposable income from year to year.
C. consumption is correlated to disposable income on a quarterly basis.
D. changes in consumption of less durable goods respond to changes in disposable income.
E. none of the above.

    7. Because the long-run marginal propensity to consume is
A. smaller than the short-run marginal propensity to consume; consumption is more volatile over the
business cycle than personal disposable income.
B. larger than the short-run marginal propensity to consume; consumption is less volatile over the busi-
ness cycle than personal disposable income.
C. larger than the short-run marginal propensity to consume; consumption is more volatile over the
business cycle than personal disposable income.
D. smaller than the short-run marginal propensity to consume; consumption is less volatile over the
business cycle than personal disposable income.
E. identical to the short-run marginal propensity to consume.

    8. For the past 30 years in the United States, the long- and short-run marginal propensities to
consume have been estimated to be
A. 0.72 and 0.94, respectively.
B. 11.2 and 4.1, respectively.
C. 0.94 and 0.77, respectively.
D. identical and equal to 0.94.
E. too volatile to attribute to a single number.

    9. Modern forward-looking theories of consumption
A. are founded on the pioneering work done by Milton Friedman and Franco Modigliani on the perma-
nent income theory and the life cycle theory, respectively.
B. are based on consumption depending on current disposable income, current wealth, and expected
paths of disposable income and wealth in the future.
C. assert that individuals make long-term consumption decisions each year, using as much information
about the present and the future as possible.
D. do not preclude individuals’ changing consumption plans as new information presents itself.
E . all of the above.

     10. Suppose that an individual receives an unexpected, one-time windfall of $1,000. To determine
its effect on future consumption,
A. preferences about the desirability of both steady consumption and the desired size of the bequest are
required.
B. it would be necessary to know the desired size of the bequest, but the desirability of steady consump-
tion is immaterial.
C. it would be necessary to know the value ascribed to steady consumption, but the desired size of the
bequest is immaterial.
D. neither the desirability of steady consumption nor the desired size of the bequest is material because
$1,000 is too small a sum to be affected by either.
E. none of the above.

    11. Preferences for steady consumption paths over variable consumption paths mean that
A. any permanent change in an individual’s disposable income must generate either a change in the
desired bequest or a comparable change in consumption.
B. the applicable marginal propensity to consume out of a permanent change in an individual’s dispos-
able income must be close to 1.
C. any temporary change in an individual’s disposable income must generate only a small change in
yearly consumption if it is to be spread out smoothly over a foreseeable lifetime.
D. all of the above.
E. a and c only.

      12. Suppose that an individual anticipated that the next calendar year’s income would be $1,000
higher than this year’s. Facing a real interest rate of 0 percent and a 20-year planning horizon, you would
expect her annual real consumption to
A. increase by $900 if the increase were permanent and $90 if it were a one-shot deal.
B. increase by $1,000 if the increase were permanent and $100 if it were a one-shot deal.
C. increase by $950 if the increase were permanent and $50 if it were a one-shot deal.
D. remain the same for one year and then increase by $1,000 if the increase were permanent and by $50
if it were temporary.
E. none of the above.
      13. Short-run marginal propensities to consume are smaller than long-run propensities in part
because
A. people need time to decide whether or not an increase in income is permanent or temporary and the
propensity applied to a permanent change is smaller than the propensity applied to a temporary change.
B. people need time to decide whether or not an increase in income is permanent or temporary and the
propensity applied to a permanent change is larger than the propensity applied to a temporary one.
C. people make rash decisions in the short run and thereby overspend.
D. it takes a long time for the consumer durables that dominate long-run consumption to be delivered
and paid for.
E. none of the above.
      14. Which of the following have been advanced to explain why estimates of the marginal propensity
to consume out of temporary increments in income are too high relative to what the theory predicts?
A. People overspend temporary windfalls because they do not believe that they are temporary.
B. People contract their consumption too far because they are liquidity constrained by their inability to
borrow against their expected return to normal income levels.
C. People discount the future significantly when they make their intertemporal consumption decisions.
D. a and b only.
E. a, b, and c.

    15. Ando and Modigliani postulated a consumption function depending on not only disposable in-
come but also the value of assets in which people keep their wealth. The estimated coefficient for asset
value
A. emerged in the neighborhood of 0.06, pretty close to the marginal propensity to consume that the
theory might predict for temporary changes in income.
B. emerged in the neighborhood of 0.7, a little low for the propensity to consume that the theory would
predict for permanent changes in income.
C. emerged as expected on the basis of theory in the 0.05 range, but the estimated marginal propensity
to consume out of income was a bit low, in the 0.7 range.
D. a and c.
E. none of the above.

    16. Suppose a permanent increase in disposable income were received by individuals with 25 years
of working lifetime ahead of them before 10 years of retirement. If they expected positive real interest
rates to prevail over the foreseeable future, then forward-looking consumption theory would predict a
marginal propensity to consume of
A. something less than 0.6 depending on expected real rates of interest.
B. exactly 0.6 regardless of the real rates of interest.
C. something over 0.6 but invariant to the real rates of interest.
D. something over 0.6 depending on the real rate of interest.
E. something over the ”Keynesian” estimate of 0.91, but unspecified because of insufficient information.

    17. Which of the following circumstances is likely to exaggerate the expected shift in an IS curve in
response to a reduction in taxes?
A. A perception that the tax change is temporary
B. A perception that the tax change is permanent
C. A prior anticipation of higher taxes throughout the foreseeable future
D. A prior anticipation that taxes would not change in the foreseeable future
E. The certain knowledge that nothing is certain but death and taxes

    18. It has been argued that, ”A tax cut must be followed later by a tax increase to pay for the
resulting deficit” is the self-fulfilling prophecy of those who use it to predict that an income windfall
from a tax reduction must be temporary. The argument can be supported by
A. appealing to forward-looking consumption theory, which predicts that a temporary increase in income
produces only a small increase in consumption.
B. noting that small consumption increases produce very little economic stimulus.
C. recalling that larger than expected gaps between actual and potential GDP mean larger deficits
spawned by enlarged transfer programs and reduced tax revenues.
D. all of the above.
E. none of the above.

     19. If permanent income is always taken to equal disposable income in the current year, then a
consumption function of the form C = a + bYD(p)
A. reveals a long-run marginal propensity to consume that is larger than the short-run marginal propen-
sity to consume.
B. reveals a long-run marginal propensity to consume that is exactly equal to the short-run marginal
propensity to consume.
C. reveals a long-run marginal propensity to consume that is smaller than the short-run marginal propen-
sity to consume.
D. defines short- and long-run marginal propensities to consume, to be sure, but insufficient information
has been provided to compare them.
E. is difficult to specify in times of uncertain income.

    20. Let the consumption function be given by C = 0.85 + 0.8YDP with permanent disposable
income specified according to YDP = 0.75YD + 0.25YD(-1). Let there be a permanent $1,000 increase
in income. Two years later, consumption will have increased by
A. $1,000.
B. $850.
C. $800.
D. Something between $600 and $800.
E. $600.



2      Analysis
In the beginning of 2008, suppose your wealth includes the following:

    1. liquid asset: $50,000 of bond with fixed interest rate being 5% per year

    2. illiquid asset: a house that can be sold for $200,000

In addition, your current income is $50,000 per year. Assume in optimality your consumption of 2008
should be $40,000.
(a), If neither your house nor your bond is not going to be traded this year, how much would your liquid
asset worth in the beginning of 2009?
(b), If you sell your current house in the beginning of 2008 and buy another one that costs $220,000 (i.e.,
you are climbing up the housing ladder), how much would your liquid asset worth in the beginning of
2009?




3      Multiple Choice Answers
1 D Topic: Consumption Behavior Page: 260
2 B Topic: Consumption Behavior Page: 261
3 A Topic: GDP vs. PDI Page: 262
4 B Topic: GDI vs. PDI Pages: 262-263
5 C Topic: Consumption Behavior Page: 262
6 C Topic: MPC Page: 267
7 B Topic: MPC Pages: 267-268
8 C Topic: MPC Pages: 267-268
9 E Topic: Forward-Looking Consumption Pages: 268-276
10 A Topic: Forward-Looking Consumption Page: 274
11 D Topic: Smooth Consumption Pages: 271-272
12 C Topic: Temporary vs. Permanent Income Changes Page: 274
13 B Topic: MPC Pages: 274-275
14 E Topic: Forward-Looking Consumption Pages: 268-276
15 D Topic: Forward Looking Consumption Page: 278
16 D Topic: Temporary vs. Permanent Income Changes Page: 274
17 B Topic: Temporary vs. Permanent Income Changes Page: 289
18 D Topic: Forward-Looking Consumption Pages: 268-276
19 B Topic: Permanent Consumption Page: 279
20 C Topic: Permanent Income Page: 279

				
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