Question 1

An individual having an unusually bad year will be on her short-run consumption function at a point ________ her long-run consumption function, with an unusually ________ saving ratio.
A) above, high
B) above, low
C) below, high
D) below, low

Accepted Answer

An unusually bad year would lead to a decrease in income and a decrease in consumption. This would shift the consumption function downward. In the short-run, the individual would still be consuming at their previous level, but using up their savings to do so, resulting in an unusually low savings ratio. Therefore, the individual would be above their long-run consumption function (Option B).

Question 2

An individual having an unusually good year will be on his short-run consumption function at a point ________ his long-run consumption function, with an unusually ________ saving ratio.
A) above, high
B) above, low
C) below, high
D) below, low

Accepted Answer

The answer of An individual having an unusually good year...

Question 3

Working with the life-cycle hypothesis, we find in a cross-section study of consumption that as income rises there is a growing proportion of ________ people and thus a ________ saving ratio.
A) retired, rising
B) retired, falling
C) working, rising
D) working, falling

Accepted Answer

According to the life-cycle hypothesis, individuals aim to maintain a relatively constant level of consumption throughout their lives by adjusting their saving and borrowing behavior over time. Therefore, as income rises, working individuals are more likely to save a larger proportion of their income in order to maintain their desired level of consumption during retirement. As a result, there is a rising saving ratio among working individuals as income increases. Retired individuals, on the other hand, have already adjusted their saving and borrowing behavior to achieve their desired level of consumption, so their saving ratio is not likely to increase with rising income.

Question 4

Replacing the simple Keynesian consumption function with the function based on the permanent-income hypothesis results in a ________ short-run multiplier, implying a ________ stable private economy.
A) higher, more
B) higher, less
C) lower, more
D) lower, less

Accepted Answer

The permanent-income hypothesis suggests that consumers base their spending on their expected long-term average income rather than their current income. This leads to a lower short-run multiplier because changes in income have a smaller effect on consumption. Consequently, the economy is more stable as it is less sensitive to short-term fluctuations in income.

Question 5

By the permanent-income hypothesis, the long-run marginal propensity to consume is
A) j.
B) k.
C) kj.
D) k - j.
E) k/j

Accepted Answer

The answer of By the permanent-income hypothesis, the long-run marginal...

Question 6

In the life-cycle hypothesis, people are assumed to have a consumption pattern that leads them to dissave
A) at no point in their life.
B) in the working years up to retirement.
C) in their retirement years.
D) in every year of their life.

Accepted Answer

According to the life-cycle hypothesis, people tend to save during their working years and dissave during their retirement years. This is because they accumulate wealth during their working years to sustain themselves during retirement when they have a limited income. Therefore, option C, which states that people dissave in their retirement years, is the best choice.

Question 7

Both the permanent-income and life-cycle hypotheses make the assumption that people prefer a ________ consumption pattern in the long run, and so have a ________ short-run MPC out of sudden changes in income.
A) smooth, low
B) smooth, high
C) jagged, low
D) jagged, high

Accepted Answer

Both permanent-income and life-cycle hypotheses assume that people prefer a smooth consumption pattern in the long run. Therefore, they have a low short-run MPC out of sudden changes in income.

Question 8

Suppose a person calculates his permanent income by adaptive expectations. Last year's permanent income was 54,000, this year's actual income is 44,000, j = 0.20, and k = 0.82. What is his consumption expenditure this year?
A) 34,840
B) 43,472
C) 36,784
D) 42,640
E) 37,720

Accepted Answer

The answer of Suppose a person calculates his permanent income...

Question 9

Suppose a person calculates her permanent income by adaptive expectations. Last year's permanent income was 38,000, this year's actual income is 41,000, j = 0.30, and k = 0.86. What is her consumption expenditure this year?
A) 30,422
B) 12,174
C) 40,226
D) 38,774
E) 33,454

Accepted Answer

The answer of Suppose a person calculates her permanent income...

Question 10

In the life-cycle hypothesis, a person who expects to work for R years earning Y dollars per year, and live for a total of L years, will consume ________ per year.
A) RY - (L - R)Y
B) LRY
C) (L - R)Y
D) (R/L)Y

Accepted Answer

The life-cycle hypothesis suggests that individuals plan their consumption and savings over their lifetime to smooth consumption. Therefore, they would consume a fraction of their lifetime earnings each year, which is represented by (R/L)Y, where R is the number of working years, L is the total number of years, and Y is the annual income.

Question 11

The life-cycle hypothesis was developed in the 1950s, primarily by the economist
A) Franco Modigliani.
B) Robert Lucas.
C) Walter Rostow.
D) Nils Hellstrom.

Accepted Answer

The life-cycle hypothesis was primarily developed by the economist Franco Modigliani in the 1950s.

Question 12

By the permanent-income hypothesis, the MPC of transitory income is
A) k.
B) j.
C) kj.
D) k - j.
E) 0.

Accepted Answer

The permanent-income hypothesis argues that individuals consume based on their long-term/permanent income, rather than their short-term/transitory income. Therefore, their marginal propensity to consume (MPC) out of transitory income would be zero, as any changes in transitory income would not significantly affect their long-term consumption patterns.

Question 13

The life-cycle hypothesis predicts there to be a rather ________ short-run multiplier and thus a rather ________ private economy.
A) low, unstable
B) low, stable
C) high, unstable
D) high, stable

Accepted Answer

The life-cycle hypothesis suggests that individuals adjust their spending patterns based on their expected lifetime income, resulting in a low short-run multiplier. This helps to stabilize the private economy as consumer spending is less volatile.

Question 14

Suppose we are working with the simplest possible Keynesian-cross multiplier, but with the permanent-income hypothesis figured in. If k = 0.88, and j = 0.25, the multiplier of a $1 change in government spending goes from ________ in the short run to ________ in the long run.
A) 8.33, 1.28
B) 1.28, 8.33
C) 8.33, 4.00
D) 1.13, 4.00
E) 4.54, 8.33

Accepted Answer

In the short run, the multiplier equals 1/(1-kj) = 1/(1-0.88*0.25) = 1.28.
In the long run, the multiplier equals 1/(1-k) = 1/(1-0.88) = 8.33.
Therefore, the multiplier of a $1 change in government spending goes from 1.28 in the short run to 8.33 in the long run. The best choice is B.

Question 15

The permanent-income hypothesis can reconcile the cross-section and time-series consumption studies by incorporating the reasonable assumption that at any one time many people are poor because they have ________ transitory income, causing them to have an unusually ________ saving ratio.
A) positive, high
B) positive, low
C) negative, high
D) negative, low

Accepted Answer

The answer of The permanent-income hypothesis can reconcile the cross-section...

Question 16

In a business cycle boom, we expect an unusually ________ proportion of actual income to be transitory, thus an unusually ________ MPC operating in the short run, which ________ the income multiplier for the short run.
A) high, low, reduces
B) high, low, increases
C) high, high, reduces
D) low, low, increases
E) low, high, reduces

Accepted Answer

In a business cycle boom, incomes are higher than usual due to increased economic activity, but this increase is likely to be temporary. Therefore, the proportion of actual income that is transitory is higher. This implies a lower MPC (Marginal Propensity to Consume) since people are likely to save more in anticipation of future uncertainty. A lower MPC reduces the income multiplier for the short run, meaning that an increase in income will result in a smaller increase in overall spending. Therefore, the best choice is A, where we see an unusually high proportion of transitory income leading to a low MPC and a decreased income multiplier for the short run.

Question 17

In the life-cycle hypothesis, people are assumed to have a consumption pattern that leads them to save
A) at no point in their life.
B) in the working years up to retirement.
C) in their retirement years.
D) in every year of their life.

Accepted Answer

The life-cycle hypothesis suggests that people save during their working years (between the ages of 25-65) in order to finance their consumption during their retirement years (after the age of 65). Therefore, the answer is B.

Question 18

According to the life-cycle hypothesis, if the average person expects to live another 48 years, the short-run MPC out of unexpected changes in income is
A) 0.52.
B) 0.48.
C) 0.9792.
D) 0.0208.

Accepted Answer

The answer of According to the life-cycle hypothesis, if the...

Question 19

The permanent-income hypothesis can reconcile the cross-section and time-series consumption studies by incorporating the reasonable assumption that at any one time many people are rich because they are enjoying unusually high ________ income, causing them to have an unusually ________ saving ratio.
A) permanent, high
B) permanent, low
C) transitory, high
D) transitory, low

Accepted Answer

The permanent-income hypothesis argues that individuals base their consumption on their expected long-term (permanent) income rather than their current income. However, individuals may also experience short-term (transitory) fluctuations in income, such as a large bonus or unexpected inheritance. These transitory income changes can cause individuals to adjust their saving or spending behavior temporarily, leading to a short-term fluctuation in consumption compared to their long-term expected consumption. Therefore, when many people are experiencing transitory high income at the same time, they will have an unusually high saving ratio despite having high income, supporting choice C.

Question 20

By the permanent-income hypothesis, for every dollar that actual income increases, consumption expenditure rises in the short run by ________ dollars.
A) kj
B) k + j
C) k/j
D) k - j
E) j + (1/k)

Accepted Answer

The answer of By the permanent-income hypothesis, for every dollar...

Quiz 15: The Economics of Consumption Behavior

An individual having an unusually bad year will be on her short-run consumption function at a point her long-run consumption function, with an unusually saving ratio.

An individual having an unusually good year will be on his short-run consumption function at a point his long-run consumption function, with an unusually saving ratio.

Working with the life-cycle hypothesis, we find in a cross-section study of consumption that as income rises there is a growing proportion of people and thus a saving ratio.

Replacing the simple Keynesian consumption function with the function based on the permanent-income hypothesis results in a short-run multiplier, implying a stable private economy.

By the permanent-income hypothesis, the long-run marginal propensity to consume is

In the life-cycle hypothesis, people are assumed to have a consumption pattern that leads them to dissave

Both the permanent-income and life-cycle hypotheses make the assumption that people prefer a consumption pattern in the long run, and so have a short-run MPC out of sudden changes in income.

Suppose a person calculates his permanent income by adaptive expectations. Last year's permanent income was 54,000, this year's actual income is 44,000, j = 0.20, and k = 0.82. What is his consumption expenditure this year?

Suppose a person calculates her permanent income by adaptive expectations. Last year's permanent income was 38,000, this year's actual income is 41,000, j = 0.30, and k = 0.86. What is her consumption expenditure this year?

In the life-cycle hypothesis, a person who expects to work for R years earning Y dollars per year, and live for a total of L years, will consume ________ per year.

The life-cycle hypothesis was developed in the 1950s, primarily by the economist

By the permanent-income hypothesis, the MPC of transitory income is

The life-cycle hypothesis predicts there to be a rather short-run multiplier and thus a rather private economy.

Suppose we are working with the simplest possible Keynesian-cross multiplier, but with the permanent-income hypothesis figured in. If k = 0.88, and j = 0.25, the multiplier of a $1 change in government spending goes from in the short run to in the long run.

The permanent-income hypothesis can reconcile the cross-section and time-series consumption studies by incorporating the reasonable assumption that at any one time many people are poor because they have transitory income, causing them to have an unusually saving ratio.

In a business cycle boom, we expect an unusually proportion of actual income to be transitory, thus an unusually MPC operating in the short run, which the income multiplier for the short run.

In the life-cycle hypothesis, people are assumed to have a consumption pattern that leads them to save

According to the life-cycle hypothesis, if the average person expects to live another 48 years, the short-run MPC out of unexpected changes in income is

The permanent-income hypothesis can reconcile the cross-section and time-series consumption studies by incorporating the reasonable assumption that at any one time many people are rich because they are enjoying unusually high income, causing them to have an unusually saving ratio.

By the permanent-income hypothesis, for every dollar that actual income increases, consumption expenditure rises in the short run by ________ dollars.