Question 1

The life-cycle model predicts that if the proportion of the population that is elderly increases over the next 20 years, then the national saving rate ______ over the next 20 years.

Accepted Answer

According to the life-cycle model, as the proportion of the population that is elderly increases, the national saving rate decreases because older individuals tend to dissave to finance their retirement. This means that the younger generations will have less savings to invest, which will lead to a lower national saving rate. Therefore, the best choice is (C) will decrease.

Question 2

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

Accepted Answer

Laibson suggests that people have a tendency to prioritize immediate satisfaction over long-term goals, which can lead to lower savings rates.

Question 3

If consumers want consumption to be as constant as possible over their life cycles and income rises gradually over their periods of employment, then if borrowing constraints prevent their wealth from falling below zero:

Accepted Answer

If consumers want consumption to be as constant as possible over their life cycles and income rises gradually over their periods of employment, then their consumption during their younger years will be lower than it will be in later parts of the life cycle. This is because they are unable to borrow to sustain their desired consumption level during their younger years due to borrowing constraints preventing their wealth from falling below zero. As their income rises during their working years, they are able to accumulate wealth and increase their consumption level to match their desired level.

Question 4

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

Accepted Answer

Laibson and other economists recognize the importance of incorporating psychological effects into the study of consumer behavior.

Question 5

If a consumer is a borrower in period one and the interest rate rises, the:

Accepted Answer

The answer of If a consumer is a borrower in...

Question 6

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

Accepted Answer

Recent work on the consumption function has shown that consumption depends on current income, expected future income, interest rates, and wealth. This is because households tend to save more when their current income is high, but also when they expect their future income to be high. Interest rates also play a role in consumption decisions, as higher interest rates encourage saving over spending. Finally, households with higher levels of wealth may be more willing to spend on consumption, as they have a greater ability to absorb financial shocks.

Question 7

Economic data suggest that when income is expected to fall by $1, consumption falls by:

Accepted Answer

The answer of Economic data suggest that when income is...

Question 8

Exhibit: Consumption, Income, and Wealth Over the Life Cycle  Consider the stylized pattern of lifetime income, consumption, saving, dissaving, and wealth shown in the above graph. Assume that consumption is constant over the entire lifetime, income is  constant over the working lifetime, the real interest rate is zero, and there is no uncertainty about life span so that wealth equals zero at the end of life.

a. If there is no populati on growth, the ratio of wealth to income will be constant for the nation. If all individuals live $T$ years and work $R$ years, the amount of wealth accumulated at the time of retirement must be enough for $T - R$ years of consumption ( $C$ per year). What is the formula for the ratio of average wealth over the whole life cycle $W$ to consumption per year, as a function of $T$ and $R$ ? That is, what is $W / C$ expressed in terms of $T$ and $R$ ?
b. If $T = 50$ and $R = 40$, what is the numerical value of $W / C$ ?

Accepted Answer

The answer of Exhibit: Consumption, Income, and Wealth Over the...

Question 9

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 is an example of time-inconsistent preferences, where the individual's present self is willing to spend excessively, with the intention of saving in the future, but when the future arrives, their present self prefers to continue spending rather than saving. This highlights a lack of consistency in decision-making over time.

Question 10

Assume that Andrew Marcus is 25 years old and expects to live to age 75.

a. If he wins $\$ 20$ million in cash (after taxes) in the lottery and retires, how much will he consume each year if he wants to have constant consumption and use up all his wealth by the time he dies? Assume the real interest rate is zero.
b. If his total income in the year he wins the lottery is his lottery winnings, what will his average propensity to consume (APC) be for that year?
c. If he has no other earnings in later years but continues his constant consumption, what will his average propensity to consume be for those later years?
d. What is Andrew's "permanent income" in the year he wins the lottery? What is his "transitory income"?

Accepted Answer

The answer of Assume that Andrew Marcus is 25 years...

Question 11

Consumers with time-inconsistent preferences:

Accepted Answer

Consumers with time-inconsistent preferences may alter their consumption decisions simply because time passes. They may initially plan to save more and consume less, but as time passes, they may give in to the temptation of spending more and saving less, leading to inconsistency in their behavior over time.

Question 12

The life-cycle hypothesis and the permanent-income hypothesis both assume that consumers seek to:

Accepted Answer

Both the life-cycle hypothesis and permanent-income hypothesis suggest that consumers prefer to smooth their consumption over their lifetimes by borrowing when young and saving when older, in order to maintain a stable level of consumption. These theories assume that consumers aim to maintain a constant standard of living over time, rather than increasing or decreasing consumption during economic expansions or recessions. While retirement may be a factor in these hypotheses, the primary focus is on overall lifetime consumption smoothing.

Question 13

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' behavior exhibits inertia.

Accepted Answer

If workers are rational optimizers, the choice between "opting in" or "opting out" of a retirement savings plan should not affect their decision, as they would make the optimal choice regardless. However, if workers exhibit inertia, the default option (whether it is to be enrolled automatically or not) could significantly impact their participation, as they might not take action to change their status.

Question 14

The pull of instant gratification may lead consumers to save ______ they would like to save.

Accepted Answer

The pull of instant gratification means that people are more likely to spend money on things they want in the present, rather than saving it for the future. Therefore, they are likely to save less than they would like to save.

Question 15

The determination of consumption as a function of current disposable income is most strongly associated with:

Accepted Answer

John Maynard Keynes is most strongly associated with the determination of consumption as a function of current disposable income, as he emphasized the importance of current income in determining the level of consumption in his theory of consumption, known as the Keynesian consumption function.

Question 16

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

A binding borrowing constraint will not affect the potency of an announced future tax cut to influence aggregate demand because households will not increase their current consumption in anticipation of the future tax cut. However, a temporary tax cut will increase the potency of a binding borrowing constraint because households will increase their current consumption in anticipation of the temporary tax cut.

Question 17

If consumers correctly anticipate their future incomes:

Accepted Answer

When consumers anticipate a future boom in their incomes, they are more likely to spend their money rather than save it. This leads to a low saving rate. On the other hand, when consumers anticipate a future recession, they are more likely to save their money as a precautionary measure, leading to a high saving rate.

Question 18

Assume that Jeannie Drago is trying to allocate her consumption over two periods of life: work and retirement. Each period is to last 20 years. To simplify, assume that all income comes at time t₁ in the middle of 20 years of work, and all expenditures come at either t₁ or t₂, 20 years later. Jeannie's budget constraint is C₁ + C₂/(1 + r/100) = Y₁ + Y₂/(1 + r/100), where the real interest rate r is 100 percent (approximately 3.5 percent per year over 20 years). Jeannie's preferences are to have equal consumption each period. a. What are $C _ { 1 }$ and $C _ { 2 }$ if $Y _ { 1 } = 1$ million and $Y _ { 2 } = 0$ ? b. What are $C _ { 1 }$ and $C _ { 2 }$ if $Y _ { 1 } = 0$ and $Y _ { 2 } = 1$ million (reflecting, for example, an individual who plans to come into a large inheritance late in life)? Do these answers depend on Jeannie's being able to borrow against the inheritance?

Accepted Answer

The answer of Assume that Jeannie Drago is trying to...

Question 19

Ken Downing behaves according to Irving Fisher's two-period model. Consumption in both periods is a normal good for Ken. Ken is initially a saver in period one. Ken loses his job in period one. His first-period income becomes his unemployment benefits, which are much lower than his period-one income had been. His expected income in period two is unchanged. Illustrate graphically how this job loss affects Ken's consumption in periods one and two.

Accepted Answer

The answer of Ken Downing behaves according to Irving Fisher's...

Question 20

The success of the "Save More Tomorrow" program is based on the assumption that consumers:

Accepted Answer

The "Save More Tomorrow" program is successful because it is designed to help consumers overcome their tendencies for immediate gratification by automatically increasing their savings rates over time, particularly as they earn more. This addresses the common behavioral finance issue where individuals struggle to save adequately due to the preference for immediate rewards over future benefits.

Quiz 16: Understanding Consumer Behavior