Question 1

The LCH theory argues that
A) over time, the saving rate of low-income people tended to rise at a faster rate than that of other income groups.
B) the aggregate saving rate depended on the age distribution within the economy.
C) over time, the aggregate saving rate was relatively constant.
D) over time, the aggregate saving rate would increase.

Accepted Answer

The LCH theory argues that the aggregate saving rate is dependent on the age distribution within the economy. This is because people typically save more during their working years and draw down their savings in retirement. Therefore, as the proportion of older individuals in the population increases, the aggregate saving rate is expected to decline.

Question 2

Suppose that medical researchers discover a new drug which slows the aging process allowing the average life span in the United States to increase to 95 years of age. The lifecycle hypothesis suggests that
A) consumption spending would increase since lifetime income increases.
B) consumption spending would increase since estimates of permanent income would increase.
C) consumption spending would decrease since savings would rise to provide income for the longer retirement periods.
D) None of the above is correct since predicted future annual incomes may not change.

Accepted Answer

The lifecycle hypothesis posits that individuals plan their consumption and savings behaviour over their lifetime. If the average lifespan increases to 95 years, people would anticipate longer retirement periods. To ensure they have enough income to support themselves during these extended retirements, they would likely increase their savings rate during their working years, leading to a decrease in consumption spending.

Question 3

In the simple Keynesian consumption function, consumption demand is
A) a function of disposable income alone.
B) a function of disposable income and an autonomous component.
C) simply an autonomous amount exogenous to the model.
D) a function of the interest rate and an autonomous component.
E) a function of the interest rate alone.

Accepted Answer

The simple Keynesian consumption function includes an autonomous component (such as non-income factors like consumer confidence or habits) in addition to being a function of disposable income. Therefore, choice B is the correct answer. The other options (choices A, C, D, and E) do not accurately reflect the components of the simple Keynesian consumption function.

Question 4

A lower interest rate
A) lowers the marginal propensity to consume out of permanent .B income.
B) raises the marginal propensity to consume out of permanent income.
C) lowers the proportion of actual income considered to be permanent income.
D) raises the proportion of actual income considered to be permanent income.

Accepted Answer

A lower interest rate will typically lead to an increase in disposable income, which would lead to an increase in consumption. This increase in consumption would likely consist of a higher portion of permanent income since people are more likely to increase their consumption for long-term goods and investments when they have more disposable income. Therefore, a lower interest rate would raise the marginal propensity to consume out of permanent income.

Question 5

The apparent conflict between the time-series and cross-section evidence on the U.S. saving ratio, where cross-section studies predict a long-run ________ in the ratio that does not emerge from the time-series studies, is ________ by the permanent-income and life-cycle hypotheses.
A) rise, resolved
B) rise, created
C) fall, resolved
D) fall, created

Accepted Answer

The apparent conflict is resolved by the permanent-income and life-cycle hypotheses, which explain why cross-section studies predict a long-run rise in the saving ratio, a trend not observed in time-series studies. These hypotheses suggest that individuals plan their savings over their lifetime, leading to predictions of a rise in savings as people age, which may not be immediately apparent in time-series data that aggregates across all age groups.

Question 6

Milton Friedman first proposed the hypothesis that individuals consume a fraction of their expected, or ________, income.
A) disposable
B) net
C) attainable
D) permanent
E) life-cycle

Accepted Answer

Milton Friedman's hypothesis is based on the idea that people tend to have a long-term perspective on their income rather than focusing solely on their current disposable income. Therefore, individuals consume a fraction of their "permanent income," which is their expected or long-term average income. This is also known as the "permanent income hypothesis."

Question 7

Keynes was concerned about an implication of his consumption theory: that as an economy becomes more prosperous, its saving rate becomes too ________ to sustain that prosperity. Such a long-term trend in the U.S. saving rate is ________ in the time-series data.
A) large, found
B) large, not found
C) small, found
D) small, not found

Accepted Answer

Keynes' theory suggests that as an economy becomes more prosperous, the saving rate decreases, which is not found in the U.S. time-series data. Therefore, option B is the correct choice.

Question 8

The permanent-income hypothesis was developed in the 1950s by economist
A) Edward Prescott.
B) James Tobin.
C) Robert Solow.
D) Milton Friedman.

Accepted Answer

The permanent-income hypothesis was developed by economist Milton Friedman in the 1950s.

Question 9

The least volatile component of current consumption expenditure is ________, and the changes in its relative importance help explain why the volatility of overall consumption has ________ since the 1950s.
A) nondurable goods, risen
B) nondurable goods, fallen
C) durable goods, stayed the same
D) durable goods, fallen
E) services, stayed the same

Accepted Answer

Services are the least volatile component of current consumption expenditure, and their relative importance has increased since the 1950s. This helps explain why the volatility of overall consumption has fallen.

Question 10

In U.S. recessions, growth in total consumption is ________, which is ________ with the workings of the permanent-income and life-cycle hypotheses.
A) largely uninterrupted, perfectly consistent
B) largely uninterrupted, rather inconsistent
C) noticeably reduced, perfectly consistent
D) noticeably reduced, rather inconsistent

Accepted Answer

During recessions, total consumption is noticeably reduced which is rather inconsistent with the permanent-income and life-cycle hypotheses, as these theories suggest that consumption should be relatively stable over time.

Question 11

The PIH and LCH theories ________ the case for activism, while the procyclical behavior of consumer spending for durable goods ________ the case for activism.
A) supports; supports
B) supports; does not support
C) do not support; does not support
D) do not support; supports

Accepted Answer

The PIH and LCH theories do not support the case for activism as they suggest that consumers make their consumption decisions based on their expected lifetime income rather than on current income. On the other hand, the procyclical behavior of consumer spending for durable goods supports the case for activism as it suggests that government policies can influence consumer spending and stabilize the economy.

Question 12

Both the permanent-income and life-cycle hypotheses are based on the crucial assumption of ________ expectations.
A) rational
B) adaptive
C) backward-looking
D) forward-looking

Accepted Answer

Both the permanent-income and life-cycle hypotheses are forward-looking, assuming that individuals make decisions based on their expectations of future income and wealth, rather than just their past income and wealth. This is a foundational assumption of these theories.

Question 13

Suppose that medical researchers discover a new drug which slows the aging process, allowing the average life span in the United States to increase to 95 years of age. The permanent-income hypothesis suggests that
A) consumption spending would increase since lifetime income increases.
B) consumption spending would increase since estimates of permanent income would increase.
C) consumption spending would decrease since savings would rise to provide income for the longer retirement periods.
D) None of the above is correct since predicted future annual incomes may not change.

Accepted Answer

The answer of Suppose that medical researchers discover a new...

Question 14

The Keynesian consumption function implies that at a given moment persons with high incomes are saving ________ persons with low incomes, a prediction which is ________ by actual cross-section consumption data.
A) a lower fraction of income than, confirmed
B) a lower fraction of income than, not confirmed
C) a higher fraction of income than, confirmed
D) a higher fraction of income than, not confirmed
E) the same fraction of income as, confirmed

Accepted Answer

The Keynesian consumption function suggests that as income increases, the proportion of income saved increases. This is because as people earn more, they can afford to save more after meeting their consumption needs. This prediction is confirmed by actual cross-section consumption data, which generally shows that higher-income individuals save a higher fraction of their income compared to lower-income individuals.

Question 15

The largest component of current consumption expenditure is ________, while the most volatile component is ________.
A) durable goods, nondurable goods
B) durable goods, services
C) services, durable goods
D) services, nondurable goods
E) nondurable goods, services

Accepted Answer

Services make up the largest component of current consumption expenditure, while nondurable goods are the most volatile.

Question 16

Both the permanent-income and life-cycle hypotheses modify Keynesian consumption theory by distinguishing the effects of
A) temporary and permanent changes in disposable income.
B) changes in the disposable income of upper income and lower income classes.
C) changes in labor income and interest income.
D) small and large changes in disposable income.

Accepted Answer

Both the permanent-income and life-cycle hypotheses focus on the effects of the duration and permanence of changes in disposable income on consumption behavior. They argue that temporary changes in income have a lesser effect on consumption than permanent changes, and that consumption decisions are influenced by long-term income expectations rather than current income alone. These theories modify Keynesian consumption theory by introducing the concept of consumption smoothing over time. The other options mentioned in the answer choices are not the main focus of these theories.

Question 17

With a temporary income tax surcharge, according to the ________, household consumption should ________.
A) LCH; stay the same
B) PIH; stay the same
C) LCH; fall since earnings over the lifecycle will decrease
D) PIH; fall since disposable income will fall

Accepted Answer

The Permanent Income Hypothesis (PIH) suggests that household consumption is determined by their long-term income expectations rather than changes in their current income. Therefore, a temporary income tax surcharge would not change household consumption according to the PIH, as it does not alter the household's long-term income expectations.

Question 18

A person is calculating his permanent income by adaptive expectations. Last year's permanent income was 38,000, this year's actual income is 44,000, and j = 0.25. This year his permanent income is
A) 39,500.
B) 42,500.
C) 59,000.
D) 20,500

Accepted Answer

The formula for calculating permanent income using adaptive expectations is: Permanent Income this year = Last year's permanent income + j * (This year's actual income - Last year's permanent income). Plugging in the values: 38,000 + 0.25 * (44,000 - 38,000) = 38,000 + 0.25 * 6,000 = 38,000 + 1,500 = 39,500.

Question 19

With a temporary income tax surcharge, according to the ________, household consumption should ________.
A) LCH; stay the same since life cycles have not changed
B) LCH; rise even though disposable income falls
C) PIH; fall since disposable income falls
D) None of the above is correct since there would be no change in "permanent" income.

Accepted Answer

The correct answer is D because both the Life Cycle Hypothesis (LCH) and the Permanent Income Hypothesis (PIH) suggest that temporary changes in income do not affect consumption significantly, as they do not alter the consumer's perception of their permanent income.

Question 20

With a temporary income tax surcharge, according to the ________, household consumption should ________.
A) PIH; fall as disposable income falls
B) PIH; rise since the decrease is disposable income is temporary
C) LCH; fall since disposable income over the lifecycle falls
D) None of the above is correct since a temporary change affects neither permanent income or relative lifecycle earnings.

Accepted Answer

The answer of With a temporary income tax surcharge, according...

Quiz 15: The Economics of Consumption Behavior

The LCH theory argues that

Suppose that medical researchers discover a new drug which slows the aging process allowing the average life span in the United States to increase to 95 years of age. The lifecycle hypothesis suggests that

In the simple Keynesian consumption function, consumption demand is

A lower interest rate

The apparent conflict between the time-series and cross-section evidence on the U.S. saving ratio, where cross-section studies predict a long-run in the ratio that does not emerge from the time-series studies, is by the permanent-income and life-cycle hypotheses.

Milton Friedman first proposed the hypothesis that individuals consume a fraction of their expected, or ________, income.

Keynes was concerned about an implication of his consumption theory: that as an economy becomes more prosperous, its saving rate becomes too to sustain that prosperity. Such a long-term trend in the U.S. saving rate is in the time-series data.

The permanent-income hypothesis was developed in the 1950s by economist

The least volatile component of current consumption expenditure is , and the changes in its relative importance help explain why the volatility of overall consumption has since the 1950s.

In U.S. recessions, growth in total consumption is , which is with the workings of the permanent-income and life-cycle hypotheses.

The PIH and LCH theories the case for activism, while the procyclical behavior of consumer spending for durable goods the case for activism.

Both the permanent-income and life-cycle hypotheses are based on the crucial assumption of ________ expectations.

Suppose that medical researchers discover a new drug which slows the aging process, allowing the average life span in the United States to increase to 95 years of age. The permanent-income hypothesis suggests that

The Keynesian consumption function implies that at a given moment persons with high incomes are saving persons with low incomes, a prediction which is by actual cross-section consumption data.

The largest component of current consumption expenditure is , while the most volatile component is .

Both the permanent-income and life-cycle hypotheses modify Keynesian consumption theory by distinguishing the effects of

With a temporary income tax surcharge, according to the , household consumption should .

A person is calculating his permanent income by adaptive expectations. Last year's permanent income was 38,000, this year's actual income is 44,000, and j = 0.25. This year his permanent income is

With a temporary income tax surcharge, according to the , household consumption should .

With a temporary income tax surcharge, according to the , household consumption should .