Question 1

Under what condition is a change in tax rates likely to affect individuals' behavior regarding consumption and saving?

Accepted Answer

The tax rate change is likely to affect individuals' behavior regarding consumption and saving if the tax cut is permanent .

Question 2

What does the empirical evidence suggest about the shape of the labor supply curve?

Accepted Answer

The substitution effect seems to dominate for most people, which means that the aggregate labor supply responds positively to an increase in the wage rate. It is therefore, an upsloping function.

Question 3

Consider the effect of a fall in the interest rate on consumption. Explain your answer using the substitution effect argument.

Accepted Answer

A fall in the interest rate lowers the reward to saving. If the interest rate falls from 10 percent to 5 percent, you earn 5¢ instead of 10¢ per year on every dollar saved. This means that the opportunity cost of spending a dollar today (instead of saving it and consuming it plus the interest income a year from now) has fallen. You will substitute toward current consumption and away from future consumption when the interest rate falls: You consume more today and save less.

Question 4

Assume an individual whose income rises at a decreasing rate up until midlife and then falls at an increasing rate. In addition, assume that her consumption is constant throughout her lifetime. With this information, draw her income and consumption functions as a function of age. Explain what is going on in each part of her life.

Accepted Answer

The answer of Assume an individual whose income rises at...

Question 5

To calculate the real wage rate, we divide the nominal wage rate by the price index. Suppose the wage rate rose from $10 per hour in 1998 to $18 per hour in 2010 and the price level rose 50 percent during the same period. Calculate the real wage rate in 2010 using 1998 as the base year. Show your work.

Accepted Answer

The answer of To calculate the real wage rate, we...

Question 6

Consider the effect of a fall in the interest rate on consumption. Explain your answer using the income effect argument. Make sure to compare and contrast the effects between a household with positive wealth and a household that is a net debtor.

Accepted Answer

The answer of Consider the effect of a fall in...

Question 7

Define the nominal wage rate.

Accepted Answer

The answer of Define the nominal wage rate....

Question 8

A candidate is running for public office and is against making any tax cuts because of a concern that this will lead to lower tax revenue and a higher budget deficit. His aides have told him that studies have shown that the income effect dominates the substitution effect along the labor supply curve. If this is true does this support the candidate's position on cutting taxes if his goal is to insure that tax revenue does not fall? Explain.

Accepted Answer

The answer of A candidate is running for public office...

Question 9

A candidate is running for public office and has made a pledge to cut taxes. His aides have told him that studies have shown that the substitution effect dominates the income effect along the labor supply curve. If this is true does this support the candidate's position on cutting taxes if his goal is to increase tax revenue? Explain.

Accepted Answer

The answer of A candidate is running for public office...

Question 10

Assume that you are an aide to a politician. Explain to your boss what would happen to the shape of the labor supply curve if the income effect is dominating the substitution effect.

Accepted Answer

The answer of Assume that you are an aide to...

Question 11

Consider a household that has a sudden unexpected increase in wealth, perhaps an inheritance from a distant relative. How will the household's consumption pattern be affected?

Accepted Answer

The answer of Consider a household that has a sudden...

Question 12

How is it that people are able to consume greater than their income during their early working careers? What are some of the things that they consume which causes this to happen in the first place?

Accepted Answer

The answer of How is it that people are able...

Question 13

Consider two households that are at the same stage in their life cycle and have similar expectations about future wage rates, prices, and so on. They expect to live the same length of time, and both plan to leave the same amount to their children. They differ only in their wealth. Because of a past inheritance, household 1 has more wealth than household 2. Which household is likely to have a higher consumption path for the rest of its life?

Accepted Answer

The answer of Consider two households that are at the...

Question 14

What is permanent income?

Accepted Answer

The answer of What is permanent income?...

Question 15

What does the data suggest about the relative impact of the substitution effect and income effect of a change in interest rates on consumption and saving?

Accepted Answer

The answer of What does the data suggest about the...

Question 16

Assume that Congress passes a one-year 10% across-the-board tax cut. What would the life-cycle theory suggest about this tax cut's effectiveness on the economy?

Accepted Answer

The answer of Assume that Congress passes a one-year 10%...

Question 17

Explain the life-cycle theory of consumption.

Accepted Answer

The answer of Explain the life-cycle theory of consumption....

Question 18

How is it possible to have negative wealth?

Accepted Answer

The answer of How is it possible to have negative...

Question 19

What would be the shape of the labor supply curve if the substitution effect was exactly equal to the income effect? Explain. How realistic is a labor supply curve of this shape?

Accepted Answer

The answer of What would be the shape of the...

Question 20

Why is a medical student likely to consume more than a high school student?

Accepted Answer

The answer of Why is a medical student likely to...

Quiz 16: Household and Firm Behavior in the Macroeconomy: a Further Look