Deck 4: Consumption, saving, and Investment

Question 1

Last year,Linus earned a salary of $25,000 and he spent $24,000,thus saving $1000.At the end of the year,he received a bonus of $1000 and he spent $500 of it,saving the other $500.What was his marginal propensity to consume?

A)0.96
B)0.50
C)0.04
D)0.02

Answer 1

0.50

Question 2

The desire to have a relatively even pattern of consumption over time is known as

A)excess sensitivity.
B)the substitution effect.
C)the consumption-smoothing motive.
D)forced saving.

Answer 2

the consumption-smoothing motive.

Question 3

With no inflation and a nominal interest rate (i)of .03,a person can trade off one unit of current consumption for ________ units of future consumption.

A)0.97
B)1.03
C)0.03
D)-0.03

Answer 3

1.03

Question 4

In forecasting consumer spending using surveys of consumer confidence,research suggests that

A)the forecasts are improved when using consumer confidence measures.
B)the forecasts are not improved when using consumer confidence measures.
C)the forecasts are improved when using consumer confidence measures for forecasts made during recessions, but not expansions.
D)the forecasts are not improved when using consumer confidence measures for forecasts made during expansions, but not recessions.

Question 5

Desired national saving equals

A)Y - C^d - G.
B)C^d + I^d + G.
C)I^d + G.
D)Y - I^d - G.

Question 6

An increase in the personal income tax rate on interest income will

A)increase desired saving because the expected real after-tax interest rate rises.
B)decrease desired saving because the expected real after-tax interest rate rises.
C)decrease desired saving because the expected real after-tax interest rate falls.
D)increase desired saving because the expected real after-tax interest rate falls.

Question 7

A small increase in the real interest rate will most likely

A)increase desired saving, but the effect will be relatively small.
B)increase desired saving substantially.
C)decrease desired saving substantially.
D)decrease desired saving, but the effect will be relatively small.

Question 8

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.

Question 9

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.

Question 10

The fraction of additional current income that a person consumes in the current period is known as the

A)consumption-smoothing motive.
B)consumption deficit.
C)saving rate.
D)marginal propensity to consume.

Question 11

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

A)1)50%.
B)3)25%.
C)5)00%.
D)6)50%.

Question 12

The yield curve generally slopes upward because

A)longer maturity bonds typically pay higher interest rates than shorter maturity bonds.
B)longer maturity bonds typically pay lower interest rates than shorter maturity bonds.
C)shorter maturity bonds have more default risk.
D)longer maturity bonds are not taxable.

Question 13

If an investor has a tax rate on interest income of 25% and the inflation rate is 4%,which bond has the lowest expected real after-tax interest rate?

A)A Treasury bond paying 9%
B)A corporate bond paying 8%
C)A Treasury bond paying 7%
D)A municipal bond paying 6%

Question 14

With a nominal interest rate of 4%,an expected inflation rate of 1%,and interest income taxed at a rate of 25%,what is the expected real after-tax interest rate?

A)3%
B)2%
C)1%
D)0%

Question 15

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 was 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.

Question 16

If the substitution effect of the real interest rate on saving is larger than the income effect of the real interest rate on saving,then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving,for someone who's a lender.

A)fall; fall
B)fall; rise
C)rise; rise
D)rise; fall

Question 17

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.

Question 18

If the substitution effect of the real interest rate on saving is smaller than the income effect of the real interest rate on saving,then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving,for someone who's a lender.

A)fall; fall
B)fall; rise
C)rise; rise
D)rise; fall

Question 19

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.

Question 20

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.

Question 21

Desired national saving would increase unambiguously if there were

A)an increase in both current output and expected future output.
B)an increase in both expected future output and government purchases.
C)an increase in both expected future output and the expected real interest rate.
D)a fall in both government purchases and expected future output.

Question 22

If the government cuts taxes today,issuing debt today and repaying the debt plus interest next year,a rational taxpayer will

A)spend the full amount of the tax cut today and reduce consumption next year.
B)increase consumption today, before taxes go up next year.
C)increase saving today, leaving consumption unchanged.
D)leave a smaller gross bequest to her or his heirs.

Question 23

Suppose the nominal interest rate is 6%,the tax rate on interest income is 30%,and expected inflation is 3%.
(a)Calculate the expected real after-tax interest rate.
(b)Calculate the expected real after-tax interest rate if the nominal interest rate falls to 4%.
(c)Calculate the expected real after-tax interest rate if the tax rate increases to 50% (with the nominal interest rate at its original value of 6%).
(d)Calculate the expected real after-tax interest rate if expected inflation increases to 5% (with the nominal interest rate at its original value of 6% and the tax rate at its original value of 30%).

Question 24

The nominal interest rate on taxable bonds is 8%,while on municipal bonds (which aren't taxable)it is 5%.The expected inflation rate is 3% and the tax rate on interest income is 40%.Calculate the expected real after-tax interest rate on both bonds.Which would be the better investment? Now suppose the actual inflation rate turned out to be 6%.Which bond was the better investment? Would your answer change if inflation had turned out to be 0%?

Question 25

What is the marginal propensity to consume,and why is it always less than one?

Question 26

If an investor has a tax rate on interest income of 30% and the inflation rate is 4%,which bond has the highest expected real after-tax interest rate?

A)A Treasury bond paying 8%
B)A corporate bond paying 7%
C)A Treasury bond paying 7%
D)A municipal bond paying 6%

Question 27

Which of the factors listed below might cause the Ricardian equivalence proposition to be violated?

A)There may be international capital inflows and outflows.
B)Consumers may not understand that an increase in government borrowing today is likely to lead to higher future taxes.
C)There may be constraints on the level of government spending.
D)There may be constraints on the level of government taxation.

Question 28

Suppose you divide your life into two periods: working age and retirement age.When you work,you earn labor income Y; when retired,you earn no labor income,but must live off your savings and the interest it earns.You save the amount S while working,earning interest at rate r,so you have (1 + r)S to live on when retired.Because you don't need to consume as much when retired,you want to set consumption when working twice as high as consumption when retired.
(a)Suppose you earn $1 million over your working life,and the real interest rate for retirement saving is 50%.How much will you save and how much will you consume in each part of your life?
(b)Suppose your current income went up to $2 million when working.Now what will you save and how much will you consume each period?
(c)Suppose a social security system will pay you 25% of your working income when you are retired.Now (with Y = $1 million,as in part (a)how much will you save and how much will you consume each period?
(d)Suppose the interest rate rises (starting from the situation in part (a).Will you save more or less?

Question 29

Jane wants to save $1000 of current income.With an IRA,no taxes are paid on income or interest until the money is withdrawn in five years.Without an IRA,taxes must be paid whenever income or interest is received.Jane's federal/state tax bracket is 35%,and the nominal interest rate is 8%.
(a)How much money will Jane have if she puts her money in an IRA and withdraws the money in five years?
(b)How much money will Jane have if she does not put her money in an IRA,but rather in a regular (taxable)savings account,for five years?
(c)How much does Jane gain in five years by using an IRA rather than a regular savings account?

Question 30

According to the Ricardian equivalence proposition,a temporary government budget deficit created by cutting taxes

A)will cause desired consumption to increase.
B)will cause future taxes to increase but will have no real economic effects.
C)will have the same real economic effects as a budget deficit created by raising government spending.
D)would have the same real effects whether or not consumers expect future taxes to change.

Question 31

Suppose the one-year T-bill rate was 5% on 1/1/2007,4% on 1/1/2008,and 6% on 1/1/2009.The GDP deflator (2004 = 100)was 110 on 1/1/2007,112 on 1/1/2008,114 on 1/1/2009,and 120 on 1/1/2010.The tax rate on interest income is 30%.
(a)Calculate the nominal after-tax rate of return for 2007,2008,and 2009.
(b)If you began with $1000 on 1/1/2007 and invested in T-bills each year (paying taxes at the end of each year),how much would you have in nominal terms on 1/1/2010? How much would you have in real terms (2004 dollars)?
(c)How much was your nominal after-tax interest earned in part (b)over the three years? How much did you earn in real (2004)after-tax dollars?

Question 32

In 1991 the federal government changed the withholding amounts for personal taxes.The change meant that people wouldn't have as much withheld from their paychecks.But there was no change in the tax code itself,so the amount of tax due in April 1992 was not changed.How would consumption and saving respond to this withholding change? (Note: you may assume a real interest rate of 0%.)

Question 33

Desired national saving would decrease unambiguously if there were

A)a decrease in current output and a decrease in taxes.
B)an increase in expected future output and a decrease in government purchases.
C)an increase in both expected future output and the expected real interest rate.
D)a fall in both government purchases and expected future output.

Question 34

The Ricardian equivalence proposition suggests that a government deficit caused by a tax cut

A)causes inflation.
B)causes a current account deficit.
C)raises interest rates.
D)doesn't affect consumption.

Question 35

The yield curve shows

A)the yields on stocks of different maturities.
B)the interest rates on bonds of different maturities.
C)the yields on stocks with differing default risk.
D)the yields on bonds with differing default risk.

Question 36

An increase in the price of capital goods will

A)increase the expected future marginal product of capital.
B)reduce the expected future marginal product of capital.
C)increase the interest cost and the depreciation cost of capital.
D)increase the interest cost but not affect the depreciation cost of capital.

Question 37

Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a 25% rate,machine B costs $10,000 and depreciates at a rate of 20%,machine C costs $20,000 and depreciates at a rate of 10%,and machine D costs $17,000 and depreciates at a rate of 11%.The expected real interest rate is 5%.

A)Machine A
B)Machine B
C)Machine C
D)Machine D

Question 38

The user cost of capital is given by the following formula,where p_K is the real price of capital goods,d is the depreciation rate,and r is the expected real interest rate.

A)uc = (r + d)/p_K
B)uc = p_K/(r + d)
C)uc = dp_K/r
D)uc = (r + d)p_K

Question 39

Sally will earn $30,000 this year and $40,000 next year.The real interest rate is 20% between this year and next year; she can borrow or lend at this rate.She has no wealth at the start of this year and plans to finish next year having consumed everything she possibly can.She would like to consume the same amount this year as next year.The inflation rate is 0%.
(a)How much should Sally save this year? How much will Sally consume in each of the two years?
(c)How would your answers change if the real interest rate was 40%?

Question 40

How would the expected real after-tax rate of return be affected by each of the following events?
(1)the tax rate on interest income increases
(2)expected inflation declines

Question 41

Suppose your company is in equilibrium,with its capital stock at its desired level.A permanent decline in the expected real interest rate now has what effect on your desired capital stock?

A)Raises it, because the future marginal productivity of capital is higher
B)Lowers it, because the future marginal productivity of capital is lower
C)Raises it, because the user cost of capital is now lower
D)Lowers it, because the user cost of capital is now higher

Question 42

The desired level of the capital stock will increase if the

A)user cost of capital increases.
B)expected future marginal product of capital increases.
C)effective tax rate increases.
D)price of capital increases.

Question 43

If a firm's expected marginal product of capital exceeds its tax-adjusted user cost of capital,the firm will

A)increase its investment spending on capital goods.
B)reduce its investment spending on capital goods.
C)not change its investment spending on capital goods.
D)increase the tax-adjusted user cost of capital.

Question 44

You are trying to figure out how much capacity to add to your factory.You will increase capacity as long as

A)the expected marginal product of capital is positive.
B)the expected marginal product of capital is greater than or equal to the marginal product of capital.
C)the expected marginal product of capital is greater than or equal to the expected marginal product of labor.
D)the expected marginal product of capital is greater than or equal to the user cost of capital.

Question 45

When a company must consider taxes in determining investment,its desired capital stock is chosen such that

A)MPK^{f = uc(}1 - t)
B)MPK^{f = uc/(}1 - t)
C)MPK^{f = t} × uc
D)t × MPK^{f = uc}

Question 46

An increase in the expected real interest rate will

A)increase the desired capital stock.
B)decrease the desired capital stock.
C)have no effect on the desired capital stock.
D)have the same effect on the desired capital stock as a decrease in corporate taxes.

Question 47

The relationship between stock prices and firms' investments in physical capital is captured by what theory?

A)User-cost-of-capital theory
B)q theory
C)Yield-curve theory
D)Keynesian theory

Question 48

Suppose your company is in equilibrium,with its capital stock at its desired level.A permanent increase in the depreciation rate now has what effect on your desired capital stock?

A)Raises it, because the future marginal productivity of capital is higher
B)Lowers it, because the future marginal productivity of capital is lower
C)Raises it, because the user cost of capital is now lower
D)Lowers it, because the user cost of capital is now higher

Question 49

Calculate the tax-adjusted user cost of capital of a machine that costs $10,000 and depreciates at a rate of 10%,when the real interest rate is 3% and the tax rate on revenue is 5%.

A)$1238
B)$1300
C)$1368
D)$1800

Question 50

You have just purchased a new DVD player to show videos to your customers.The DVD player cost $500,and you depreciate the machine at a rate of 25% each year.You can borrow money from the bank at 10%,or receive 6% for depositing money at the bank.The expected inflation rate in the coming year is 5%.You used the company's own funds to purchase the DVD player.The firm's user cost of capital for the first year is

A)$130
B)$150
C)$155
D)$175

Question 51

Calculate the user cost of capital of a machine that costs $5000 and depreciates at a rate of 25%,when the nominal interest rate is 10% and the expected inflation rate is 5%.

A)$150
B)$500
C)$1500
D)$5000

Question 52

Calculate the user cost of capital of a machine that costs $5000 and depreciates at a 25% rate,when the nominal interest rate is 5% and the expected inflation rate is 10%.

A)$5000
B)$1500
C)$1000
D)$100

Question 53

A technological improvement will

A)increase the desired capital stock.
B)decrease the desired capital stock.
C)have no effect on the desired capital stock.
D)have the same effect on the desired capital stock as an increase in corporate taxes.

Question 54

Calculate the user cost of capital of a machine that costs $100,000 and depreciates at a rate of 25%,when the nominal interest rate is 4% and the expected inflation rate is 1%.

A)$3000
B)$25,000
C)$28,000
D)$29,000

Question 55

Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a rate of 25%,machine B costs $10,000 and depreciates at a rate of 20%,machine C costs $20,000 and depreciates at a rate of 10%,and machine D costs $17,000 and depreciates at a rate of 11%.The expected real interest rate is 0%.

A)Machine A
B)Machine B
C)Machine C
D)Machine D

Question 56

If the stock market value of a firm is $10 million and the firm owns $15 million of capital,then Tobin's q equals

A)2/3.
B)1)
C)3/2.
D)4)

Question 57

If the rate of depreciation increases,then user cost ________ and the desired capital stock ________.

A)falls; falls
B)falls; rises
C)rises; rises
D)rises; falls

Question 58

A firm should invest more if Tobin's q

A)equals zero.
B)is less than one.
C)equals one.
D)is more than one.

Question 59

Calculate the user cost of capital of a machine that costs $5000 and depreciates at a rate of 25%,when the expected real interest rate is 5%.

A)$150
B)$500
C)$1500
D)$5000

Question 60

Tobin's q is equal to

A)the ratio of capital's market value to its replacement cost.
B)the ratio of capital's replacement cost to its market value.
C)the expected after-tax real interest rate.
D)the stock market value of a firm.

Question 61

Cummins,Hubbard,and Hassett found that investment responded to a tax change that affected the user cost of capital,with an elasticity of

A)0)
B)-0.25.
C)-0.66.
D)-1.

Question 62

Your firm has capital stock of $10 million and a depreciation rate of 15%.Gross investment is $3 million.How much is net investment?

A)$1.5 million
B)$2.0 million
C)$2.5 million
D)$3.5 million

Question 63

What is the q theory of investment? Who developed it? What is q,and what do different values of q imply? How is q related to the stock market value of a firm and its capital stock?

Question 64

An economy has government purchases of 2000.Desired national saving and desired investment are given by S^d = 200 + 5000r + 0.10Y - 0.20G
I^d = 1000 - 4000r
When the full-employment level of output equals 5000,then the real interest rate when the goods market is in equilibrium will be

A)7)78%.
B)10.00%.
C)14.44%.
D)23.33%.

Question 65

At the start of the year,your firm's capital stock equaled $100 million,and at the end of the year it equaled $105 million.The average depreciation rate on your capital stock is 20%.Gross investment during the year equaled

A)$1 million.
B)$5 million.
C)$7 million.
D)$25 million.

Question 66

In the goods market equilibrium condition for a closed economy,the total demand for goods equals

A)C^d + I^d
B)C^d + I^d + G
C)C^d + I^d - G
D)C^d + G - I^d

Question 67

Cummins,Hubbard,and Hassett studied the effects of taxes on investment by

A)seeing if investment spending is correlated with taxes on investment.
B)examining what happened to investment when major tax reforms took place.
C)raising tax rates on certain businesses and testing their reaction.
D)raising tax rates on equipment and reducing tax rates on structures.

Question 68

An economy has government purchases of 2000.Desired national saving and desired investment are given by S^d = 200 + 5000r + 0.10Y - 0.20G
I^d = 1000 - 4000r
When the full-employment level of output equals 5000,then the level of investment when the goods market is in equilibrium will be

A)66.8.
B)422.4.
C)600.0.
D)688.9.

Question 69

A firm's output (Y)depends on how much capital (K)it has,according to the equation: Y = 20K - K².The real interest rate is 6% per year,the depreciation rate of capital is 14% per year and the price of a unit of capital is $80,and each unit of output sells for $1.
(a)For capital levels of 0 to 6,how much is output?
(b)For capital levels from 1 to 6,calculate the marginal product of capital.
(c)How many units of capital does the firm desire?
(d)If the real interest rate was 1% per year,how many units of capital would the firm desire?

Question 70

When desired national saving equals desired national investment (in a closed economy),what market is in equilibrium?

A)The goods market
B)The money market
C)The foreign exchange market
D)The stock market

Question 71

A firm has current and future marginal productivity of capital given by MPK = 10,000 - 2K + N,and marginal productivity of labor given by MPN = 50 - 2N + K.The price of capital is $5000,the real interest rate is 10%,and capital depreciates at a 15% rate.The real wage rate is $15.
(a)Calculate the user cost of capital.
(b)Find the firm's optimal amount of employment and the size of the capital stock.

Question 72

Draw a diagram showing the determination of a firm's optimal capital stock,showing the relationship between the user cost of capital and the future marginal product of capital.Suppose the real interest rate declines.Show what happens to the firm's optimal capital stock.What happens to the firm's desired investment?

Question 73

An economy has government purchases of 1000.Desired national saving and desired investment are given by S^d = 200 + 5000r + 0.10Y - 0.20G
I^d = 1000 - 4000r
When the full-employment level of output equals 5000,then the real interest rate that clears the goods market will be

A)1)11%.
B)5)56%.
C)16.67%.
D)21.11%.

Question 74

How would the desired capital stock be affected by a decline in the user cost of capital?

Question 75

One way of writing the goods-market equilibrium condition for a closed economy is

A)Y = C + G + S
B)Y = C^d + G^d + S
C)S^d = I^d
D)Y - C^d - G - S^d = I^d

Question 76

At the start of the year,your firm's capital stock equaled $10 million,and at the end of the year it equaled $15 million.The average depreciation rate on your capital stock is 20%.Net investment during the year equaled

A)$3 million.
B)$4 million.
C)$5 million.
D)$7 million.

Question 77

An economy has full-employment output of 5000.Government purchases are 1000.Desired consumption and desired investment are given by C^d = 3000 - 2000r + 0.10Y
I^d = 1000 - 4000r
Where Y is output and r is the real interest rate.The real interest rate that clears the goods market is equal to

A)1)25%.
B)2)50%.
C)8)33%.
D)25.00%.

Question 78

What is the difference between gross investment and net investment?

A)Net investment = gross investment minus taxes
B)Net investment = gross investment minus net factor payments
C)Net investment = gross investment minus inventory accumulation
D)Net investment = gross investment minus depreciation

Question 79

Any change in the economy that raises desired national saving for a given value of the real interest rate will shift the desired national saving curve to

A)the right and increase the real interest rate.
B)the right and decrease the real interest rate.
C)the left and increase the real interest rate.
D)the left and decrease the real interest rate.

Question 80

You have just purchased a home that cost $250,000.The nominal mortgage interest rate is 8% per annum,mortgage interest payments are tax deductible,and you are in a 30% tax bracket.The expected inflation rate is 4%.Maintenance and other expenses are 8% of the initial value of the house.What is the real user cost of your house?

A)$20,000
B)$24,000
C)$27,000
D)$30,000