Deck 9: A Two-Period Model: The Consumption-Savings Decision and Credit Markets

Question 1

We limit ourselves to two periods in the intertemporal model of the business cycle because

A) we need to concentrate on the two phases of the business cycle.
B) we can assume that people can live two periods of, say, 30 years.
C) this is all we need to emphasize the intertemporal trade-off.
D) we need an even number of periods.

Answer 1

this is all we need to emphasize the intertemporal trade-off.

Question 2

Savings in our model are

A) durable consumption.
B) non-durable consumption.
C) postponed consumption.
D) money.

Answer 2

postponed consumption.

Question 3

At the endowment point,we have the property that

A) c = c'.
B) c = y - t.
C) y - t = y' - t'.
D) y = y'.

Answer 3

c = y - t.

Question 4

We collapse the consumer's current-period and future-period budget constraints into a single lifetime budget constraint by

A) assuming no default.
B) substituting for savings.
C) eliminating consumption smoothing.
D) assuming the consumer knows the future.

Question 5

The endowment point is the consumption bundle in which

A) both consumptions are the same.
B) current consumption equals current output less current government expenses.
C) no savings occur.
D) the interest rate equals zero.

Question 6

Intertemporal decisions involve economic decisions

A) made within a given period of time.
B) made in between two periods of time.
C) involving trade-offs across periods of time.
D) that ignore concerns about the future.

Question 7

If we represents a two-period consumer's lifetime wealth and r denotes the real rate of interest,the slope of the consumer's budget line is equal to

A) r × we.
B) -
C) -
D) - (1 + r).

Question 8

The endowment point is the consumption bundle in which

A) first-period consumption is equal to zero.
B) second-period consumption is equal to zero.
C) the consumer finds the most utility.
D) consumption is equal to disposable income in each period.

Question 9

A one-period bond is a promise to repay

A) units of goods in the second period.
B) r units of goods in the second period.
C) (1 + r) units of goods in the second period.
D) the original amount lent.

Question 10

If we represents a two-period consumer's lifetime wealth and r denotes the real rate of interest,the horizontal (current consumption)intercept of the consumer's budget line is equal to

A) we.
B) (1 + r)we.
C)
D)

Question 11

We use a two-period model because

A) the business cycle has two phases: contraction and recovery.
B) it is the simplest dynamic model.
C) we want to make a distinction between young and old households.
D) this is the horizon of the politicians that formulate policy.

Question 12

If we represents a two-period consumer's lifetime wealth and r denotes the real rate of interest,the vertical (future consumption)intercept of the consumer's budget line is equal to

A) we.
B) (1 + r)we.
C)
D)

Question 13

The simplest device to analyze dynamic decisions is a

A) one-period model.
B) two-period model.
C) model that includes only the number of years of a typical consumer's lifetime.
D) continuous time model.

Question 14

The desire to smooth consumption is reflected in

A) the consumer's budget constraint.
B) the curvature in a consumer's indifference curves.
C) choice between present and future.
D) the production possibilities frontier.

Question 15

The consumer's lifetime budget constraint states that

A) the present value of lifetime consumption must be equal to the present value of lifetime gross income.
B) the present value of lifetime consumption must be equal to the present value of lifetime disposable income.
C) the present value of lifetime consumption plus the present value of lifetime taxes to be paid must be equal to the present value of lifetime income.
D) the present value of lifetime taxes to be paid by the consumer must be equal to the present value of government spending.

Question 16

In the basic two-period model,

A) credit markets have frictions.
B) the government borrows at a lower interest rate than do consumers.
C) some consumers will always default on their debts.
D) consumers do not default on their debts.

Question 17

Lifetime wealth is

A) the quantity of assets the consumer has in the current period.
B) current income plus future income.
C) current income minus discounted future taxes.
D) the present value of disposable income.

Question 18

Why don't consumers work in the two-period model?

A) It's a convenient simplification.
B) It would make no difference to the model if consumers could work.
C) People who participate in real-world credit markets do not work.
D) We don't know how to include workers in the model.

Question 19

Consumption smoothing refers to

A) the tendency of all consumers to choose the same amount of current consumption.
B) the tendency of consumers to seek a consumption path over time that is smoother than income.
C) the tendency of consumers to seek an income path over time that is smoother than consumption.
D) consumer's concerns about going heavily into debt.

Question 20

The endowment point is the consumption bundle in which

A) households maximize utility.
B) households are indifferent to interest rate changes.
C) permanent income is maximized.
D) savings are zero.

Question 21

If current income increases as much as future income decreases

A) current consumption decreases.
B) current consumption stays the same.
C) current consumption increases.
D) We do not know.

Question 22

A temporary increase in income today leads to

A) a small increase in current consumption.
B) a large increase in current consumption.
C) a small decrease in future consumption.
D) a large decrease in future consumption.

Question 23

An increase in first-period income results in

A) an increase in first-period consumption, an increase in second-period consumption, and an increase in saving.
B) an increase in first-period consumption, a decrease in second-period consumption, and an increase in saving.
C) a decrease in first-period consumption, an increase in second-period consumption, and an increase in saving.
D) an increase in first-period consumption, an increase in second-period consumption, and a decrease in saving.

Question 24

If the interest rate increases,lifetime wealth (we)

A) increases.
B) stays constant.
C) decreases.
D) changes in an ambiguous way.

Question 25

A temporary decrease in taxes leads to

A) a small increase in current consumption.
B) a large increase in current consumption.
C) a small decrease in future consumption.
D) a large decrease in future consumption.

Question 26

A consumer is a borrower if

A) optimum current consumption is less than current disposable income.
B) optimum current consumption is greater than current disposable income.
C) future disposable income is greater than current disposable income.
D) the consumer's indifference curves are relatively steep.

Question 27

The property of diminishing marginal rate of substitution follows from the property that the indifference curves are

A) downward sloping.
B) upward sloping.
C) bowed in toward the origin.
D) bowed out from the origin.

Question 28

Why is it important that consumers respond differently to temporary and permanent increases in their incomes?

A) This implies that consumption will be highly sensitive to temporary changes in income.
B) This implies that a temporary tax cut will have a larger effect than a permanent one on current consumption.
C) this tells us that the timing of income increases for consumers is irrelevant.
D) this has implications for the relative effects of temporary and permanent tax cuts.

Question 29

For a household in a (c,c')graph,the optimal consumption bundle is

A) to the left of the endowment point.
B) to the right of the endowment point.
C) on the endowment point.
D) dependent on other factors.

Question 30

A consumer is a lender if

A) optimum current consumption is less than current disposable income.
B) optimum current consumption is greater than current disposable income.
C) current disposable income is greater than future disposable income.
D) the consumer's indifference curves are relatively flat.

Question 31

We assume that the representative consumer's preferences exhibit the properties that

A) they are convex and that more is always preferred to less.
B) more is always preferred to less and that each consumer has one strictly favorite period of time for consumption.
C) each consumer has one strictly favorite period of time for consumption and that current and future consumption are both normal goods.
D) current and future consumption are both normal goods and that the consumer likes diversity in his or her consumption bundle.

Question 32

For a lender in a (c,c')graph,the optimal consumption bundle is

A) to the left of the endowment point.
B) to the right of the endowment point.
C) on the endowment point.
D) dependent on other factors.

Question 33

A permanent increase in income leads to

A) a small increase in current consumption.
B) a large increase in current consumption.
C) a small decrease in future consumption.
D) a large decrease in future consumption.

Question 34

With higher future taxes

A) current consumption declines.
B) current consumption stays the same.
C) current consumption increases.
D) current consumption depends on other factors.

Question 35

In the two-period model,r denotes

A) real income.
B) the nominal interest rate.
C) the real interest rate.
D) current taxes.

Question 36

For a borrower in a (c,c')graph,the optimal consumption bundle is

A) to the left of the endowment point.
B) to the right of the endowment point.
C) on the endowment point.
D) dependent on other factors.

Question 37

To assure a well-defined solution to the consumers' intertemporal choice problems,we must assume that consumers' preferences exhibit the properties that

A) consumers are all identical and that more is always preferred to less.
B) more is preferred to less and that consumers prefer diversity.
C) consumers like diversity and that more is sometimes preferred to less.
D) more is sometimes preferred to less and that first-period consumption and second-period consumption are both normal goods.

Question 38

A permanent decrease in taxes leads to

A) a small increase in current consumption.
B) a large increase in current consumption.
C) a small decrease in future consumption.
D) a large decrease in future consumption.

Question 39

For the consumer to be at an optimum,it must be the case that

A) MRSc,c' =
B) MRSc,c' = (1 + r)
C) MRTc,c' =
D) MRTc,c' = (1 + r)

Question 40

A good proxy for the flow of consumption services would be

A) aggregate consumption.
B) consumption of services and consumption of durables.
C) consumption of durables and consumption of nondurables.
D) consumption of nondurables and consumption of services.

Question 41

The idea that a permanent increase in income causes a larger increase in consumption than a temporary change in income is called the

A) Friedman-Lucas theory.
B) permanent income hypothesis.
C) Ricardian equivalence theorem.
D) intertemporal substitution effect.

Question 42

For a lender,an increase in the real interest rate

A) definitely reduces current consumption and increases future consumption.
B) reduces current consumption and has an uncertain effect on future consumption.
C) has an uncertain effect on current consumption and increases future consumption.
D) has an uncertain effect on both current and future consumption.

Question 43

For a borrower,an increase in the real interest rate

A) definitely reduces current consumption and increases future consumption.
B) reduces current consumption and has an uncertain effect on future consumption.
C) has an uncertain effect on current consumption and increases future consumption.
D) has an uncertain effect on both current and future consumption.

Question 44

In the absence of a financial system,the two-period model without taxes predicts that

A) consumption is more volatile that output.
B) consumption is as volatile as output.
C) consumption is less volatile than output.
D) We do not know.

Question 45

If government spending is held constant and Ricardian equivalence holds,

A) an increase in the government budget deficit is always matched by a reduction in private savings.
B) an increase in government savings is always matched by an increase in the government budget deficit.
C) an increase in government savings is always matched by an equal increase in private savings.
D) an increase in government savings is always matched by an equal reduction in private savings.

Question 46

The Ricardian equivalence theorem implies that

A) government debt policy must be handled correctly for the economy to prosper.
B) the amounts of government spending are neutral.
C) an increase in government spending has no effect on the economy, as long as there is an equal change in taxes.
D) the timing of taxes collected by the government is neutral.

Question 47

The Ricardian Equivalence says

A) whatever the level of government expenses, consumption is the same.
B) whatever the timing of taxes, consumption is the same.
C) higher government expenses reduce consumption.
D) an increase in current consumption has to lead to a decrease in future consumption.

Question 48

In the data,which of the following is most volatile?

A) real GDP
B) consumption of durables
C) consumption of nondurables
D) consumption of services

Question 49

Ricardian equivalence implies

A) that when the government borrows more, the market real interest rate goes up.
B) that if the government saves less, then the nation saves less.
C) that when taxes are cut people consume more.
D) that consumers will save their tax cuts to pay their future taxes.

Question 50

Macroeconomists are interested in how consumers respond to changes in the market real interest rate because

A) interest rates are an important channel for the effects of monetary and fiscal policies.
B) substitution effects and income effects net out in the aggregate.
C) of the permanent income hypothesis.
D) future income affects current consumption.

Question 51

For a competitive equilibrium in a two-period model,all of the following must be true except

A) each consumer picks first- and second-period consumption given the real interest rate.
B) there must be an equal number of borrowers and lenders.
C) the government's present-value budget constraint holds.
D) the credit market clears.

Question 52

The government's present value budget constraint states that

A) taxes must equal government spending in each period.
B) the present value of government spending must be equal to the present value of consumers' disposable incomes.
C) the present value of government spending must be equal to the present value of taxes.
D) the government may run deficits each and every year, as long as the deficits are sufficiently small.

Question 53

The two primary explanations for the excess volatility of consumption are

A) consumers' limited life spans and credit market imperfections.
B) credit market imperfections and changes in market prices.
C) changes in market prices and distorting taxes.
D) distorting taxes and consumers' limited life spans.

Question 54

If government spending does not change,an increase in the government deficit leads to

A) an increase in current consumption.
B) a decrease in current consumption.
C) no change in current consumption.
D) it depends on the marginal propensity to consume.

Question 55

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

A) pure substitution effect.
B) substitution effect and a positive income effect.
C) substitution effect and a negative income effect.
D) substitution effect and an income effect whose sign depends on whether the consumer is initially a borrower or a lender.

Question 56

An increase in the real interest rate

A) increases savings for both borrowers and lenders.
B) increases savings for borrowers, but has an uncertain effect on the savings of lenders.
C) increases savings for lenders, but has an uncertain effect on the savings of borrowers.
D) has an uncertain effect on the savings of both borrowers and lenders.

Question 57

The Ricardian equivalence implies that

A) the level of government spending has no impact.
B) the level of taxes has no impact.
C) the distribution of government expenses though time has no impact.
D) the distribution of taxes through time has no impact.

Question 58

In a two-period model,government spending is financed through

A) taxes and transfer payments.
B) taxes and issuing debt.
C) taxes and redeeming debt.
D) taxes only.

Question 59

The substitution effect of a change in the real interest rate is an example of

A) an intratemporal substitution effect.
B) an intertemporal substitution effect.
C) an atemporal substitution effect.
D) a temporary substitution effect.

Question 60

An increase in second-period income results in

A) an increase in first-period consumption, an increase in second-period consumption, and an increase in saving.
B) an increase in first-period consumption, a decrease in second-period consumption, and an increase in saving.
C) a decrease in first-period consumption, an increase in second-period consumption, and an increase in saving.
D) an increase in first-period consumption, an increase in second-period consumption, and a decrease in saving.

Question 61

Which condition would generate a violation of the Ricardian Equivalence?

A) downward sloping labor supply curve
B) underdeveloped credit markets
C) inflationary monetary policy
D) deflationary monetary policy

Question 62

When different consumers pay different amounts of taxes,Ricardian equivalence may fail because

A) alternative ways of collecting the same tax revenue can affect the distribution of income.
B) consumers can become jealous of one another.
C) such differences in taxes create credit market imperfections.
D) higher taxes on more talented people may be politically popular.

Question 63

Distorting taxes can invalidate Ricardian equivalence because

A) they confuse consumers about the need for government to repay its debt.
B) alternative ways of collecting the same tax revenue produce different amounts of lost welfare.
C) they are inferior to lump-sum taxes.
D) they are more popular, politically, than lump-sum taxes.

Question 64

An important reason why Ricardian equivalence may fail is if

A) borrowing and lending are done through intermediaries.
B) government debt incurred today may not be paid off until after some current consumers are deceased.
C) state and local governments also engage in debt finance.
D) some consumers are borrowers, while other consumers are lenders.

Question 65

The Ricardian Equivalence holds only if

A) the government is altruistic.
B) there are no binding credit constraints.
C) the government runs deficits.
D) the government runs surpluses.

Question 66

Which of the following is not a reason for the Ricardian equivalence theorem to fail to hold?

A) tax distortions
B) people can borrow from the government.
C) finite-lived people.
D) credit market imperfections.