Question 1

The tendency to reduce current consumption and increase future consumption as the real interest rate increases is called
A) the substitution effect of the real interest rate on saving.
B) the income effect of the real interest rate on saving.
C) the net effect of the real interest rate on saving.
D) the substitution effect of the real interest rate on investment.

Accepted Answer

The description given in the question is of the substitution effect, which is the change in behavior that occurs when the opportunity cost of one option (in this case, current consumption) becomes relatively more expensive due to an increase in the price of another option (in this case, future consumption). This effect is captured by the substitution effect of the real interest rate on saving, as individuals are incentivized to save more in order to consume more in the future when the interest rate rises. Therefore, the correct choice is A.

Question 2

The Canadian consumption function is given by C = 50 + 0.75 Y. This implies that
A) Canadians spend 75 percent of their income on average.
B) each Canadian spends 75 percent of her/his income.
C) Canadians on average spend 75 cents out of each additional dollar earned.
D) Canadian spend 50 dollars of their income on average.

Accepted Answer

The consumption function shows that for each additional dollar earned, Canadians will spend 0.75 cents of that dollar. Therefore, option C is the correct choice. Option A is not correct as it implies that Canadians spend 75% of their income, which is not necessarily true. Option B is not correct as it implies that each individual Canadian spends exactly 75% of their income, which is also not necessarily true. Option D is not correct as it only refers to the constant term in the consumption function and does not reflect the relationship between income and consumption.

Question 3

Three factors that cause interest rates among different financial instruments to vary are
A) default risk, expected inflation, and taxability.
B) default risk, current inflation, and taxability.
C) default risk, maturity, and taxability.
D) default risk, expected inflation, and maturity.

Accepted Answer

Default risk, maturity, and taxability all have significant impacts on interest rates among different financial instruments. Default risk refers to the likelihood that the borrower will not be able to repay the loan; instruments with higher default risk will typically have higher interest rates to compensate for this risk. Maturity refers to the length of time until the instrument matures and the principal is repaid; generally, longer maturities will result in higher interest rates due to the increased risk and uncertainty over a longer period of time. Taxability refers to whether the interest earned on the instrument is subject to taxation; instruments that are tax-exempt or have tax advantages will typically have lower interest rates because of their relative attractiveness to investors. Current inflation is not as strong a factor as expected inflation in determining interest rates, as investors are more concerned with inflation expectations over the life of the investment.

Question 4

The housing price in Canada nearly doubled in the period 1995-2006. This implies that
A) Canadian homeowners income has increased, leading to more consumption.
B) Canadian homeowners wealth has increased, leading to more consumption.
C) Canadian homeowners wealth has decreased, leading to lower consumption.
D) Canadian homeowners income has decreased, leading to less consumption.

Accepted Answer

The increase in housing prices implies that Canadian homeowners' wealth has increased, leading to more consumption. They would have more money to spend on other goods and services due to the increase in their home's value.

Question 5

The nominal interest rate is 10%, the expected inflation rate is 5%, and the combined state-federal tax is 35%.The expected real after-tax rate of return is
A) 1.50%.
B) 3.25%.
C) 5.00%.
D) 6.50%.

Accepted Answer

The answer of The nominal interest rate is 10%, the...

Question 6

If you lend money to the government by buying a one-year Treasury bill, your interest rate is 4%, but if you lend money to XYZ corporation by buying a one-year XYZ bond, you can earn 7%. What is the main reason for this difference in interest rates?
A) higher tax rate on the XYZ bond
B) higher inflation on the XYZ bond
C) higher default risk on the XYZ bond
D) higher expected real after-tax rate of return on the XYZ bond

Accepted Answer

The main reason for the difference in interest rates between the Treasury bill and the XYZ bond is due to the higher default risk on the XYZ bond. The government is considered to be a safer borrower than a corporation, and therefore, investors demand a higher return for taking on the additional risk.

Question 7

An increase in housing prices in Canada will likely have stronger effect on the aggregate consumption than a similar increase in the stock prices, because
A) there are more Canadian stockholders than Canadian homeowners.
B) stock prices are far more volatile than the housing prices.
C) changes in stock prices are seen as permanent changes in wealth.
D) housing prices are more volatile than the stock prices.

Accepted Answer

Stock prices are known to be more volatile than housing prices, which means they can change significantly and unpredictably very quickly. Therefore, changes in stock prices are less likely to have a lasting impact on consumer spending than an increase in housing prices.

Question 8

With a nominal interest rate of 8%, an expected inflation rate of 3%, and interest income taxed at a 25% rate, what is the expected after-tax real interest rate?
A) 5%
B) 3.75%
C) 3%
D) 1%

Accepted Answer

The answer of With a nominal interest rate of 8%,...

Question 9

A temporary increase in government purchases, given the level of output, will lead to
A) a higher desired consumption and a higher desired national saving.
B) a lower desired consumption and a lower desired national saving.
C) a higher desired consumption and a lower desired national saving.
D) a lower desired consumption and a higher desired national saving.

Accepted Answer

The answer of A temporary increase in government purchases, given...

Question 10

Franco the economist uses data for Canada to estimate a Keynesian consumption function: C^d = 0.46 + 0.92Y In this equation, what is the marginal propensity to consume? A) 0.46 B) 0.50 C) 0.92 D) 1.38

Accepted Answer

The coefficient in front of the income variable (Y) represents the marginal propensity to consume. In this case, the coefficient is 0.92, so the answer is C.

Question 11

An increase in expected future output while holding today's output constant would
A) increase today's desired consumption and increase desired national saving.
B) increase today's desired consumption and decrease desired national saving.
C) decrease today's desired consumption and increase desired national saving.
D) decrease today's desired consumption and decrease desired national saving.

Accepted Answer

The answer of An increase in expected future output while...

Question 12

Desired national saving would unambiguously increase if there were
A) an increase in current output and expected future output.
B) an increase in expected future output and government purchases.
C) an increase in expected future output and the expected real interest rate.
D) a fall in both government purchases and expected future output.

Accepted Answer

The answer of Desired national saving would unambiguously increase if...

Question 13

The effect of an increase in current consumption that results when a higher real interest rate makes a consumer richer is called
A) the substitution effect of the real interest rate on saving.
B) the income effect of the real interest rate on saving.
C) the net effect of the real interest rate on saving.
D) the substitution effect of the real interest rate on consumption.

Accepted Answer

The effect described is the income effect, which occurs when a change in the real interest rate affects a consumer's purchasing power and willingness to consume. As the real interest rate increases, the consumer's effective income increases, which leads to an increase in current consumption. This is different from the substitution effect, which occurs when a change in the real interest rate affects the relative prices of saving and consumption. The net effect refers to the overall impact of both the income and substitution effects on saving and consumption, but does not specify which effect is responsible for the increase in current consumption. Choice D is incorrect because the effect is on consumption, not saving.

Question 14

The effect of changes in wealth on consumers' spending is
A) significantly higher if the change in wealth arises from the housing rather than that arises from stock market.
B) significantly lower if the change in wealth arises from the housing rather than that arises from stock market.
C) significantly higher if the change in wealth arises from saving rather than that arises from the housing.
D) not dependent on the type of wealth.

Accepted Answer

Changes in wealth from housing tend to have a more significant impact on consumer spending because housing is a more stable and long-term asset compared to stocks, which are more volatile.

Question 15

Aunt Agatha has just left her nephew $5000. The most likely response is for her nephew to
A) increase current consumption, but not future consumption.
B) decrease current consumption, but increase future consumption.
C) increase future consumption, but not current consumption.
D) increase both current consumption and future consumption.

Accepted Answer

Receiving an unexpected sum of money, such as an inheritance, typically leads individuals to increase their spending in both the short term (current consumption) and save or invest a portion for the long term (future consumption), reflecting an overall increase in their consumption possibilities.

Question 16

The stock market just crashed; the Dow Jones Industrial Average fell by 750 points. You would expect the effect on aggregate consumption to be the largest if which of the following facts were true?
A) The crash had been preceded by a large run-up in the price of stocks.
B) Most stocks were owned by insurance companies.
C) Most stocks were owned by pension funds that invested in the market.
D) Many individuals had invested in the stock market immediately prior to the crash.

Accepted Answer

If many individuals had invested in the stock market immediately prior to the crash, then they may feel poorer and more cautious about their spending, causing a larger effect on aggregate consumption. Preceding run-ups in the stock market or ownership by insurance companies or pension funds may not have as direct of an effect on individual consumers' behavior.

Question 17

When a person gets an increase in current income, what is likely to happen to consumption and saving?
A) Consumption increases and saving increases.
B) Consumption increases and saving decreases.
C) Consumption decreases and saving increases.
D) Consumption decreases and saving decreases.

Accepted Answer

When a person's current income increases, typically, both consumption and saving increase. This is because the person has more disposable income, part of which is likely to be spent on goods and services (increasing consumption) and part of which may be saved for future use (increasing saving).

Question 18

When a person receives an increase in wealth, what is likely to happen to consumption and saving?
A) Consumption increases and saving increases.
B) Consumption increases and saving decreases.
C) Consumption decreases and saving increases.
D) Consumption decreases and saving decreases.

Accepted Answer

When a person receives an increase in wealth, they are likely to increase their consumption, as they have more money to spend. However, their saving may decrease, as they may feel that they can afford to spend more without worrying about saving as much. Therefore, option B is the best choice.

Question 19

If the aggregate consumption function is C = 20 + 0.75 Y, the aggregate saving function will be
A) S = 20 -0.75Y
B) S = 20 +0.75 Y
C) S = -20 + 0.75 Y
D) S = -20 +0.25 Y

Accepted Answer

The answer of If the aggregate consumption function is C...

Question 20

An increase in expected real interest rates would probably cause desired national saving to rise because
A) less must be saved to reach a given saving target.
B) the increased return makes saving more attractive.
C) the government would respond by increasing expenditures.
D) current interest rates would fall in response to higher expected real interest rates in the future.

Accepted Answer

When expected real interest rates rise, the return on saving increases which makes saving more attractive. This would lead to an increase in desired national saving as people would want to save more to earn the higher return.

Quiz 4: Consumption, Saving, and Investment

The tendency to reduce current consumption and increase future consumption as the real interest rate increases is called

The Canadian consumption function is given by C = 50 + 0.75 Y. This implies that

Three factors that cause interest rates among different financial instruments to vary are

The housing price in Canada nearly doubled in the period 1995-2006. This implies that

The nominal interest rate is 10%, the expected inflation rate is 5%, and the combined state-federal tax is 35%.The expected real after-tax rate of return is

If you lend money to the government by buying a one-year Treasury bill, your interest rate is 4%, but if you lend money to XYZ corporation by buying a one-year XYZ bond, you can earn 7%. What is the main reason for this difference in interest rates?

An increase in housing prices in Canada will likely have stronger effect on the aggregate consumption than a similar increase in the stock prices, because

With a nominal interest rate of 8%, an expected inflation rate of 3%, and interest income taxed at a 25% rate, what is the expected after-tax real interest rate?

A temporary increase in government purchases, given the level of output, will lead to

Franco the economist uses data for Canada to estimate a Keynesian consumption function: Cd = 0.46 + 0.92Y In this equation, what is the marginal propensity to consume?

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

Desired national saving would unambiguously increase if there were

The effect of an increase in current consumption that results when a higher real interest rate makes a consumer richer is called

The effect of changes in wealth on consumers' spending is

Aunt Agatha has just left her nephew $5000. The most likely response is for her nephew to

The stock market just crashed; the Dow Jones Industrial Average fell by 750 points. You would expect the effect on aggregate consumption to be the largest if which of the following facts were true?

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

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

If the aggregate consumption function is C = 20 + 0.75 Y, the aggregate saving function will be

An increase in expected real interest rates would probably cause desired national saving to rise because

Franco the economist uses data for Canada to estimate a Keynesian consumption function: C^d = 0.46 + 0.92Y In this equation, what is the marginal propensity to consume?