Question 1

According to the permanent-income theory, if individuals A and B have the same average annual income but A's income fluctuates greatly from year to year while B receives an almost even flow of income each year, then

Accepted Answer

The permanent-income theory suggests that individuals base their consumption on their expected long-term average income rather than their current income. Therefore, individual A, who experiences greater income fluctuations, will rely less on current income for consumption decisions compared to B, who has a more stable income.

Question 2

The permanent-income theory of consumption implies that

Accepted Answer

The permanent-income theory of consumption, proposed by Milton Friedman, suggests that people base their consumption on their expected long-term average income rather than their current income. This implies that changes in income will have a smaller effect on consumption in the short run, as people adjust their spending gradually. Therefore, the short-run multiplier, which measures the immediate impact of a change in income on consumption, is smaller than the long-run multiplier, which captures the effect over a longer period as people adjust their consumption patterns to their new income levels.

Question 3

Consumption is an important element of aggregate demand because it

Accepted Answer

Consumption accounts for roughly 70 percent of GDP.

Question 4

Assume a worker at age 25 with annual earnings of $45,000 who wants to retire at age 65 and expects to live until age 75.How much would the worker consume annually?

Accepted Answer

The worker has 40 years to save for retirement (from age 25 to 65) and expects to live for another 10 years after retirement (from age 65 to 75). Assuming the worker saves a constant amount annually and spends the rest, the total savings over 40 years will be used to fund 10 years of retirement. If the worker earns $45,000 annually, to find out how much they would consume annually, we need to calculate how much needs to be saved each year to allow for equal annual consumption during retirement. Let's denote the annual consumption by C and the annual savings by S. Since the total earnings are $45,000, we have C + S = $45,000. The total savings over 40 years, which is 40S, will be used to fund 10 years of retirement consumption, so 40S = 10C. By substituting the first equation into the second, we find that the worker needs to save $9,000 annually (which is $45,000 - C) to afford an annual consumption of $36,000 both before and after retirement.

Question 5

If we compare the life-cycle theory of consumption with the permanent-income theory we can conclude that they both

Accepted Answer

Both the life-cycle theory of consumption and the permanent-income theory are based on microeconomic foundations, which means that they consider individual behavior and decision-making when analyzing consumption patterns.

Question 6

The life-cycle theory of consumption implies that

Accepted Answer

The life-cycle theory of consumption suggests that individuals plan their consumption and savings behaviour over their lifetime. They aim to smooth consumption across different periods of their life. This implies that the marginal propensity to consume (mpc) out of wealth is small because individuals save wealth for future consumption. The mpc out of permanent income is larger than the mpc out of transitory income because individuals see permanent income as a long-term basis for consumption, while transitory income is seen as temporary and more likely to be saved. Changes in stock values can affect the economy by altering wealth and thus consumption, but the effect is moderated by the tendency to smooth consumption over time. Lastly, an individual's mpc out of permanent income may change with age as their saving and consumption goals evolve. Therefore, all the statements A through D are implications of the life-cycle theory of consumption.

Question 7

The permanent-income theory of consumption asserts that people prefer a stable level of consumption throughout their lives and

Accepted Answer

The permanent-income theory of consumption assumes that individuals calculate their consumption behavior based on their average expected lifetime income, which is reflected in choice B. This theory does not imply that individuals will forgo temporary or transitory opportunities for higher income and consumption (choice A) or that the short-run MPC is greater than the long-run MPC (choice D). Additionally, the theory does not suggest that individuals will always save the same fraction of their current income (choice E).

Question 8

The debate about different consumption theories can be viewed as a debate over whether

Accepted Answer

The debate about different consumption theories is mainly focused on the size of the marginal propensity to consume (MPC) - which is the proportion of each additional dollar of income that is spent on consumption. Some economists argue that the MPC is large, meaning that a change in income has a big effect on consumption, while others argue that it is small. This debate is fundamental to understanding the impact of economic policies, such as fiscal stimulus or taxation.

Question 9

If you are age 20, have no accumulated wealth, and have an expected average annual income of $36,000, how much should you consume each year if you want to retire at age 65 and expect to live until age 80? You desire to leave no estate and to consume an equal amount in each of the next 60 years.

Accepted Answer

To retire at age 65 and consume an equal amount in each of the next 60 years, we need to calculate the Present Value (PV) of the yearly consumption at the time of retirement. Let's assume an inflation rate of 2% and a nominal interest rate of 6%.

PV = C * [(1-(1+r)^-n)/r*(1+i)^n]
where
C = Annual Consumption = ?
r = Nominal Interest Rate = 6%
i = Inflation Rate = 2%
n = Number of Years = 60

We need to solve for C, the annual consumption.
PV = $0 (We desire to leave no estate)

0 = C * [(1-(1+0.06)^-60)/0.06*(1+0.02)^60]
C = $27,326 (Rounded to the nearest dollar)

Therefore, the answer is C) $27,000 (rounded down to the nearest thousand to ensure we do not outlive the planned retirement)

Question 10

When the aggregate consumption function is defined as C = C? + cYD, then

Accepted Answer

In the equation C = C? + cYD, c represents the marginal propensity to consume (MPC), which is the change in consumption resulting from a one-unit change in disposable income. Since c is a constant, the MPC is also constant at all levels of disposable income.

Question 11

According to the life-cycle theory of consumption, what should have occurred after the stock market crash of 1987?

Accepted Answer

According to the life-cycle theory of consumption, people consume more when they think their permanent income has increased, therefore, the loss of wealth in the stock market crashes, perceived as a permanent loss, leads to a decrease in current consumption.

Question 12

The long-run marginal propensity to consume (mpc) is

Accepted Answer

In the long run, consumers adjust their consumption habits more fully to changes in income, leading to a larger marginal propensity to consume compared to the short run.

Question 13

The life-cycle theory of consumption can be summarized as follows:

Accepted Answer

The life-cycle theory of consumption posits that people plan their consumption and saving patterns to optimize the lifetime benefit from their disposable income. This means that people aim to balance their consumption and savings over their lifetime to ensure that they can meet their needs and goals both in the present and in the future. The theory suggests that people tend to consume more during their working years when their incomes are higher, and save more during their retirement years when their incomes are lower.

Question 14

According to the life-cycle theory of consumption, an individual's

Accepted Answer

The life-cycle theory of consumption suggests that individuals smooth out their consumption over their lifetime, anticipating periods of higher and lower income. This implies that the marginal propensity to consume (mpc) out of transitory income (unexpected, short-term income changes) is fairly small, as individuals prefer to maintain a stable consumption pattern rather than adjust significantly to temporary income changes.

Question 15

According to the permanent-income theory of consumption, a person whose income fluctuates widely from year to year will have

Accepted Answer

According to the permanent-income theory of consumption, individuals base their consumption on their expected long-term income, rather than on their current income. Therefore, a person whose income fluctuates widely from year to year will have a lower apc in high-income years than in low-income years because they will be less likely to increase their consumption in response to a temporary increase in income.

Question 16

The life-cycle theory of consumption was first advanced by

Accepted Answer

The life-cycle theory of consumption was first advanced by Franco Modigliani in 1954. Modigliani received the Nobel Prize in Economics in 1985 for his contributions to the theory of household savings and his analysis of the interdependence of savings and investment in markets with imperfect competition.

Question 17

According to the permanent-income theory

Accepted Answer

The permanent-income theory suggests that people base their consumption on their expected long-term average income, rather than their current income. This means that temporary changes in income do not lead to proportionate changes in consumption, and consumption changes may not be immediate or directly tied to current income fluctuations or interest rate changes.

Question 18

Which of the following theories of consumption behavior was introduced by Milton Friedman?

Accepted Answer

The permanent-income hypothesis was introduced by Milton Friedman. This theory suggests that people's consumption decisions are based on their expected long-term income rather than their current income or short-term fluctuations in income.

Question 19

According to the simplified life-cycle theory of consumption, a retired person with zero income from labor would

Accepted Answer

According to the simplified life-cycle theory of consumption, a retired person with zero income from labor would consume a fraction of accumulated wealth based upon her/his life expectancy. This means they would budget their savings to last throughout their expected lifetime.

Question 20

In 1968, President Johnson and Congress implemented a temporary surcharge on personal and corporate income taxes.What was the effect of this?

Accepted Answer

The answer of In 1968, President Johnson and Congress implemented...

Quiz 14: Consumption and saving