Question 1

Suppose consumption in year 2 (C₂)is on the horizontal axis and consumption in year 1 (C₁)is on the vertical axis.An increase in the interest rate: A)makes borrowers better off and lenders worse off. B)causes more people to shift their consumption from year 2 to year 1. C)causes the budget line to rotate outward along the horizontal axis. D)will reduce savings in year 2.

Accepted Answer

An increase in the interest rate makes future consumption cheaper relative to present consumption, causing the budget line to rotate outward along the horizontal axis, as people can achieve more future consumption for the same amount of present consumption.

Question 2

For a risk-loving individual,with return on the X-axis and total utility on the Y-axis,the slope of the total utility curve:
A)increases at an increasing rate.
B)has a constant slope.
C)increases at a decreasing rate.
D)decreases at an increasing rate.

Accepted Answer

A risk-loving individual derives increasing marginal utility from each additional unit of return, leading to an increasing slope of the total utility curve.

Question 3

In a two-year period,if a higher interest rate causes consumption in year 1 to rise:
A)the income effect associated with the higher interest rate is greater than the substitution effect.
B)the substitution effect associated with the higher interest rate is greater than the income effect.
C)the income effect of the higher interest rate is negative.
D)the substitution effect of the higher interest rate is positive.

Accepted Answer

The income effect of a higher interest rate can increase consumption if the individual feels wealthier due to higher future income from savings, outweighing the substitution effect which would typically encourage saving over consumption.

Question 4

In the intertemporal consumer choice model,an increase in _____ will alter the slope of the budget line.
A)saving
B)the interest rate
C)future income
D)borrowing

Accepted Answer

The intertemporal consumer choice model considers decisions made by consumers over time, with the current period and a future period being the two periods of interest. The interest rate plays a crucial role in this model as it determines the opportunity cost of current consumption in terms of future consumption. An increase in the interest rate raises the opportunity cost of current consumption, making future consumption more attractive relative to current consumption. As a result, the slope of the budget line changes, becoming steeper. Thus, an increase in the interest rate alters the slope of the budget line, making choice B the correct answer.

Question 5

Consider a two-year period where a consumer has an income of $10,000 in year 1 and $8,000 in year 2.The consumer can borrow or lend at a rate of 10 percent.If the consumer decides to save $1,000 in year 1,it means:
A)his consumption will be equal in both years.
B)he will have a higher consumption in year 2 than in year 1.
C)he considers consumption in year 1 as an inferior good.
D)the cost of future consumption will increase.

Accepted Answer

By saving $1,000 in year 1 and earning interest at a rate of 10 percent, the consumer will have $1,100 available for consumption in year 2 (assuming the entire amount is saved and not spent in year 1). Therefore, the consumer will have a higher consumption in year 2 than in year 1.

Question 6

The expected utility from an investment is defined as _____.
A)the summed value of each possible utility weighted by its probability
B)the expected returns from an investment weighted by its risk.
C)the expected probability of high returns on an investment
D)the summed value of each possible rate of return discounted for inflation

Accepted Answer

The definition of expected utility is the summed value of each possible utility (or outcome) weighed by its probability. This takes into account both the potential gains and losses of an investment as well as their likelihoods.

Question 7

An individual is considering consumption in two periods.He has decided to borrow $1,000 in period 1,given his endowment and the interest rate.Other things remaining the same,if the interest rate increases,he will:
A)borrow less than $1,000.
B)continue to borrow $1,000.
C)borrow more than $1,000.
D)borrow more or less depending upon whether or not the substitution effect of the change is greater than the income effect.

Accepted Answer

If the interest rate increases, the cost of borrowing increases, so the individual's demand for borrowing decreases. Therefore, he will borrow less than $1,000.

Question 8

A reduction in an individual's future income will cause:
A)consumption to fall in both time periods because consumption in both years are normal goods.
B)a fall in consumption in the future period but not the current period since the price of future consumption relative to current consumption did not change.
C)consumption to fall in the future period and rise in the current period as the consumer substitutes more current consumption for the future consumption.
D)an increase in current consumption if interest rates are high enough to induce consumption.

Accepted Answer

A reduction in future income affects consumption in both periods because individuals typically smooth their consumption over time, considering their lifetime income. When future income decreases, individuals adjust their consumption downward in both the present and the future to maintain a balanced consumption pattern over their lifetime. This behavior is consistent with the theory of intertemporal choice, which suggests that consumption in both periods are normal goods, and a decrease in income will lead to a decrease in consumption of these goods.

Question 9

When comparing T-bills and stocks,a risk-averse investor may choose to invest in T-bills although stocks give higher average returns because _____.
A)investing in stocks involves a long term commitment
B)investing in stocks involves a higher degree of risk
C)stocks are less liquid than T-bills
D)stocks cannot be bought and sold in a secondary market

Accepted Answer

A risk-averse investor is less willing to take on higher levels of risk, even if it means potentially higher returns. Stocks are generally considered riskier investments compared to T-bills, which are backed by the U.S. government and considered very safe. Therefore, the investor may choose T-bills over stocks even if the average returns on stocks are higher.

Question 10

Expected return is defined as _____.
A)the summed value of each possible rate of return discounted for inflation
B)the average probability of profit on a fair investment
C)the expected probability of high returns on an investment
D)the summed value of each possible rate of return weighted by its probability

Accepted Answer

Expected return is the summed value of each possible rate of return weighted by its probability. This calculation takes into account the likelihood of each potential return and weighs them accordingly.

Question 11

Fred is considering consumption between two periods and is earning an income of $1,000 in both periods.If the interest rate is 8 percent,Fred borrows $500,but if the interest rate rises to 18 percent,Fred saves $500.Is this behavior economically reasonable?
A)No,Fred would borrow less because of the higher interest rate but would still borrow a positive amount.
B)No,Fred might not borrow at all,but would not start saving.If Fred wanted to save he would have saved at the lower interest rate too.
C)Yes,the change in interest rates will cause his endowment point to shift,allowing him to become a saver.
D)Yes,the higher interest rate will raise the cost of current consumption,inducing him to cut back current consumption.He could cut back so much that he becomes a saver.

Accepted Answer

The higher interest rate will raise the cost of current consumption, inducing Fred to cut back on current consumption. If he cuts back enough, he could become a saver. This behavior is economically reasonable as it follows the basic principles of intertemporal choice and rational decision-making. Option A is incorrect as Fred can still borrow but at a lower amount. Option B is incorrect as Fred can save at a higher interest rate as it would yield higher returns. Option C is incorrect as the change in interest rates does not necessarily mean that Fred will become a saver.

Question 12

Consider the income and consumption of an individual between two time periods.If consumption in period 2 (C₂)is on the horizontal axis,consumption in period 1 (C₁)is on the vertical axis,and the interest rate is 11 percent,the slope of the budget constraint must be _____. A)0.11 B)0.9 C)1.11 D)11

Accepted Answer

The slope of the budget constraint is the ratio of the change in consumption between the two periods to the change in income, which equals (1 + interest rate). Therefore, the slope of the budget constraint with an 11 percent interest rate is 1.11. Alternatively, we can rearrange the budget constraint equation C₂ = (1 + r)C₁ and solve for C₂, which gives us C₂ = (1 + r)C₁ / (1 + r) = C₁, implying that the budget constraint is a straight line with slope 1. Therefore, the slope of the budget constraint must be 0.9 (i.e., 1/1.11).

Question 13

Suppose Microsoft stock will provide either a return of 10 or 20 percent over the next year and that the probability of the former outcome is 0.25 while the probability of the latter is 0.75.If the utility an investor derives from a 10 percent return on Microsoft stock is 200 and the utility the investor derives from a 20 percent return is 400,the investor's expected utility from holding Microsoft stock is _____.
A)300
B)350
C)250
D)400

Accepted Answer

The expected utility is calculated by multiplying each outcome's utility by its probability and summing these products: (0.25 * 200) + (0.75 * 400) = 50 + 300 = 350.

Question 14

Brenda starts a business for $150,000 that gives her a 50% chance of losing and a 50% chance of gaining an expected annual return of $75,000.John is content with a job that pays him $75,000 per year with near certainty;there is only about a 1% chance of losing his job each year.Suppose risk is on the horizontal axis and return on the vertical axis,Brenda's indifference curve for risk and return:
A)is flatter than John's.
B)is steeper than John's.
C)has the same slope as John's.
D)is horizontal.

Accepted Answer

Brenda's indifference curve is flatter than John's because she is willing to tolerate more risk for a higher potential return. John's indifference curve is steeper because he is content with a lower return and wants to avoid any risk. Therefore, the best choice would depend on the individual's risk tolerance and preference for return.

Question 15

Other things remaining the same,in the intertemporal consumer choice model a change in the endowment point:
A)produces a parallel shift in the consumer's budget line.
B)alters the relative cost of future and present consumption.
C)pivots the budget line.
D)reduces the cost of current consumption.

Accepted Answer

A change in the endowment point alters the relative cost of future and present consumption, which in turn produces a parallel shift in the consumer's budget line.

Question 16

In a two-year period,suppose Gloria has $10,000 in income in year 1 and $4,300 in income in year 2.In order to maintain her optimal consumption of $8,000 in year 1 and $6,500 in year 2,she can borrow or lend at a rate of 10 percent.If Gloria's income stream changes such that she earns $3,000 in Year 1 and $12,000 in Year 2,the budget line will:
A)shift out away from the origin.
B)pivot about the endowment point.
C)pivot about the intercept on the axis representing year 2 income.
D)remain unchanged.

Accepted Answer

The answer of In a two-year period,suppose Gloria has $10,000...

Question 17

Suppose Microsoft stock will provide either a return of 10 or 20 percent over the next year and that the probability of the former outcome is 0.25 while the probability of the latter is 0.75.The expected return on Microsoft stock over the next year is thus _____%.
A)15
B)12.5
C)17.5
D)20

Accepted Answer

The expected return is calculated as (0.25 * 10) + (0.75 * 20) = 2.5 + 15 = 17.5%.

Question 18

For a risk-averse individual,with return on the X-axis and total utility on the Y-axis,the slope of the total utility curve:
A)increases at an increasing rate.
B)has a constant slope.
C)increases at a decreasing rate.
D)is always negative.

Accepted Answer

A risk-averse individual tends to have diminishing marginal utility for additional expected return, which means that the slope of the total utility curve increases at a decreasing rate. This reflects the concept of decreasing marginal utility.

Question 19

Consider an individual for whom consumption in two periods is a normal good.Other things remaining the same,if the interest rate increases,then:
A)he is worse off.
B)he is better off.
C)he will spend more in each period.
D)he will choose to save more.

Accepted Answer

The answer of Consider an individual for whom consumption in...

Question 20

An individual who is considering consumption between two time periods (year 1 and year 2)has an endowment of $20,000 in year 1 and $15,000 in year 2.If the interest rate is 5 percent,what is the maximum approximate amount that can be spent on consumption in year 1?
A)$35,000
B)$20,000
C)$35,750
D)$34,250

Accepted Answer

The individual can consume the entire $20,000 from year 1 and borrow against the $15,000 from year 2. The present value of $15,000 from year 2 at a 5% interest rate is $15,000 / 1.05 = $14,285.71. Therefore, the maximum amount that can be spent in year 1 is $20,000 + $14,285.71 = $34,285.71, which is approximately $34,250.

Quiz 5: Using Consumer Choice Theory

Suppose consumption in year 2 (C₂) is on the horizontal axis and consumption in year 1 (C₁) is on the vertical axis.An increase in the interest rate:

For a risk-loving individual,with return on the X-axis and total utility on the Y-axis,the slope of the total utility curve:

In a two-year period,if a higher interest rate causes consumption in year 1 to rise:

In the intertemporal consumer choice model,an increase in _____ will alter the slope of the budget line.

Consider a two-year period where a consumer has an income of $10,000 in year 1 and $8,000 in year 2.The consumer can borrow or lend at a rate of 10 percent.If the consumer decides to save $1,000 in year 1,it means:

The expected utility from an investment is defined as _____.

An individual is considering consumption in two periods.He has decided to borrow $1,000 in period 1,given his endowment and the interest rate.Other things remaining the same,if the interest rate increases,he will:

A reduction in an individual's future income will cause:

When comparing T-bills and stocks,a risk-averse investor may choose to invest in T-bills although stocks give higher average returns because _____.

Expected return is defined as _____.

Fred is considering consumption between two periods and is earning an income of $1,000 in both periods.If the interest rate is 8 percent,Fred borrows $500,but if the interest rate rises to 18 percent,Fred saves $500.Is this behavior economically reasonable?

Consider the income and consumption of an individual between two time periods.If consumption in period 2 (C₂) is on the horizontal axis,consumption in period 1 (C₁) is on the vertical axis,and the interest rate is 11 percent,the slope of the budget constraint must be _____.

Other things remaining the same,in the intertemporal consumer choice model a change in the endowment point:

Suppose Microsoft stock will provide either a return of 10 or 20 percent over the next year and that the probability of the former outcome is 0.25 while the probability of the latter is 0.75.The expected return on Microsoft stock over the next year is thus _____%.

For a risk-averse individual,with return on the X-axis and total utility on the Y-axis,the slope of the total utility curve:

Consider an individual for whom consumption in two periods is a normal good.Other things remaining the same,if the interest rate increases,then:

An individual who is considering consumption between two time periods (year 1 and year 2) has an endowment of $20,000 in year 1 and $15,000 in year 2.If the interest rate is 5 percent,what is the maximum approximate amount that can be spent on consumption in year 1?