Question 1

According to Friedman's permanent-income hypothesis, if the marginal propensity to consume out of permanent income equals 0.9 and current income equals $55,000 (of which $5,000 is transitory income), then consumption should equal:

Accepted Answer

The answer of According to Friedman's permanent-income hypothesis, if the...

Question 2

According to Friedman's permanent-income hypothesis, the marginal propensity to consume out of permanent income is _____ the marginal propensity to consume out of transitory income.

Accepted Answer

Friedman's permanent-income hypothesis suggests that individuals base their consumption decisions more on their long-term, or "permanent," income expectations rather than on short-term, or "transitory," income changes. Therefore, the marginal propensity to consume out of permanent income is greater than that out of transitory income, as individuals are more likely to save or not immediately spend unexpected, temporary income increases.

Question 3

According to the permanent-income hypothesis, consumption depends primarily on _____ income.

Accepted Answer

The permanent-income hypothesis postulates that consumption is driven by permanent income, which is the level of income that an individual expects to receive over their lifetime rather than their current income or transitory fluctuations in income. This is because individuals tend to smooth out their consumption over their lifetime based on their expected permanent income.

Question 4

Milton Friedman argued that, over long periods of time, the average propensity to consume is constant because, over these long periods of time:

Accepted Answer

Friedman argued that the permanent component of income, which is stable over time, dominates the variation in income, leading to a constant average propensity to consume.

Question 5

Transitory income is:

Accepted Answer

Transitory income refers to random deviations from an individual's average or permanent income, often due to unexpected events or temporary changes.

Question 6

According to the permanent-income hypothesis, if consumers receive a permanent increase in their salary then they will:

Accepted Answer

The permanent-income hypothesis suggests that consumers base their spending patterns on their expected long-term income rather than their current income. Therefore, if consumers receive a permanent increase in their salary, they are more likely to increase their spending in the current year to align with their expected long-term income. This implies that B is the correct answer.

Question 7

Recent research by Laibson and other economists recognizes the importance of incorporating _____ effects into the study of consumer behaviour.

Accepted Answer

Laibson and other economists emphasize the role of psychological effects, such as behavioral biases and decision-making processes, in understanding consumer behavior.

Question 8

According to the permanent income hypothesis, households will finance a temporary increase in taxes by: reducing _____ or increasing _____.

Accepted Answer

Households will finance a temporary increase in taxes by reducing saving or increasing borrowing, according to the permanent income hypothesis. This is because they aim to smooth consumption over time, rather than adjusting it dramatically in response to temporary changes in income or taxes.

Question 9

The success of the "Save More Tomorrow" program assumes that consumers:

Accepted Answer

The "Save More Tomorrow" program is designed to help consumers increase their savings by committing to save more in the future, addressing the issue of self-control and the tendency for instant gratification.

Question 10

Milton Friedman viewed current income as the sum of permanent income and:

Accepted Answer

Milton Friedman viewed current income as the sum of permanent income and transitory income. Permanent income is the long-term average of income and represents a person's ongoing earning capacity, while transitory income is short-term and unpredictable. Friedman believed that people base their spending habits on their long-term average income (permanent income) rather than short-term fluctuations (transitory income).

Question 11

Recent work on the consumption function suggests that consumption depends on:

Accepted Answer

Recent work on the consumption function suggests that consumption depends on current income, expected future income, interest rates, and wealth. This is known as the permanent income hypothesis, which states that individuals base their consumption on their expected long-term income rather than just their current income. Interest rates and wealth also play a role in shaping consumption behavior.

Question 12

If consumers correctly anticipate their future incomes:

Accepted Answer

If consumers anticipate a boom, they expect higher future incomes, leading them to save less in the present, thus resulting in a lower saving rate.

Question 13

If consumers obey the permanent-income hypothesis and have rational expectations, then policy changes affect consumption when the policy changes:

Accepted Answer

According to the permanent-income hypothesis, consumers base their consumption decisions on their expected future income instead of their current income. Therefore, policy changes that affect expectations about future income will have an impact on consumption. This means that policy changes will affect consumption when they change expectations.

Question 14

Whether workers must "opt into" or "opt out of" a retirement savings plan _____ make a difference if workers are rational optimizers and _____ make a difference if workers' behaviour exhibits inertia.

Accepted Answer

If workers are rational optimizers, they will make the same decision regardless of the default option, so it would not make a difference. However, if workers exhibit inertia, the default option (opt-in or opt-out) can significantly influence their decision, making a difference.

Question 15

A binding borrowing constraint will _____ the potency of an announced future tax cut to influence aggregate demand but will _____ the potency of a temporary tax cut.

Accepted Answer

The answer of A binding borrowing constraint will _____ the...

Question 16

According to the permanent-income hypothesis, if consumers receive a one-time income bonus, then they will:

Accepted Answer

According to the permanent-income hypothesis, consumers base their consumption decisions on their long-term average income rather than short-term fluctuations. Therefore, if consumers receive a one-time income bonus, they are likely to save most of it rather than increase their spending in the current year.

Question 17

If consumers have rational expectations and follow the permanent-income hypothesis, their current consumption will increase when:

Accepted Answer

According to the permanent-income hypothesis, consumers base their current consumption on their expected long-term average income. An unexpected inheritance increases their perceived wealth and thus their long-term income, leading to an increase in current consumption. Choices A, B, and D involve anticipated changes, which should already be factored into their consumption decisions according to the rational expectations theory.

Question 18

Suppose that the government is considering two tax cuts, one temporary and one permanent. Each cut will give each taxpayer the same amount in the first year. The permanent-income hypothesis predicts that:

Accepted Answer

The permanent-income hypothesis suggests that individuals base their consumption on their long-term income expectations. Therefore, a permanent tax cut, which increases long-term disposable income, is likely to lead to more extra consumption in the first year compared to a temporary tax cut, which is seen as a short-term increase in income.

Question 19

A consumer spending excessively today, intending to start saving for retirement tomorrow, but deciding to continue spending when tomorrow arrives is an example of:

Accepted Answer

This scenario involves time-inconsistent preferences, where the consumer intends to save for retirement in the future but fails to follow through when the future arrives. This is a common behavioral finance phenomenon that suggests people have difficulty making and sticking to long-term financial plans.

Question 20

Economist David Laibson suggests that people end up saving less than they wish because of:

Accepted Answer

Laibson's theory, called hyperbolic discounting, is based on the idea that people will choose immediate rewards over greater long-term benefits. This theory suggests that people may have good intentions or preferences to save, but struggle to resist the temptation of spending money on immediate desires. This "pull of instant gratification" can lead people to save less than they wish.

Quiz 19: The Microfoundations of Consumption and Investment

According to Friedman's permanent-income hypothesis, if the marginal propensity to consume out of permanent income equals 0.9 and current income equals $55,000 (of which $5,000 is transitory income) , then consumption should equal: