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Homework answers / question archive / Chapter 4 Consumption, Saving, and Investment 1) Desired national saving equals A) Y - - G

**Chapter 4 Consumption, Saving, and Investment**

1) Desired national saving equals

A) *Y -*

*- G*.

B)

+

+ *G*.

C)

+ *G*.

D) *Y* -

- *G*.

2) With no inflation and a nominal interest rate (i) of .03, a person can trade off one unit of current consumption for ________ units of future consumption.

A) 0.97

B) 1.03

C) .03

D) -.03

3) The desire to have a relatively even pattern of consumption over time is known as

A) excess sensitivity.

B) the substitution effect.

C) the consumption-smoothing motive.

D) forced saving.

4) When a person gets an increase in current income, what is likely to happen to consumption and saving?

A) Consumption increases and saving increases.

B) Consumption increases and saving decreases.

C) Consumption decreases and saving increases.

D) Consumption decreases and saving decreases.

5) Last year, Linus earned a salary of $25,000 and he spent $24,000, thus saving $1,000. At the end of the year, he received a bonus of $1,000 and he spent $500 of it, saving the other $500. What was his marginal propensity to consume?

A) .96

B) .50

C) .04

D) .02

6) The fraction of additional current income that a person consumes in the current period is known as the

A) consumption-smoothing motive.

B) consumption deficit.

C) saving rate.

D) marginal propensity to consume.

7) An increase in expected future output while holding today's output constant would

A) increase today's desired consumption and increase desired national saving.

B) increase today's desired consumption and decrease desired national saving.

C) decrease today's desired consumption and increase desired national saving.

D) decrease today's desired consumption and decrease desired national saving.

8) When a person receives an increase in wealth, what is likely to happen to consumption and saving?

A) Consumption increases and saving increases.

B) Consumption increases and saving decreases.

C) Consumption decreases and saving increases.

D) Consumption decreases and saving decreases.

9) Aunt Agatha has just left her nephew $5000. The most likely response is for her nephew to

A) increase current consumption, but not future consumption.

B) decrease current consumption, but increase future consumption.

C) increase future consumption, but not current consumption.

D) increase both current consumption and future consumption.

10) The stock market just crashed; the Dow Jones Industrial Average fell by 750 points. You would expect the effect on aggregate consumption to be the largest if which of the following facts was true?

A) The crash had been preceded by a large run-up in the price of stocks.

B) Most stocks were owned by insurance companies.

C) Most stocks were owned by pension funds that invested in the market.

D) Many individuals had invested in the stock market immediately prior to the crash.

11) An increase in the personal income tax rate on interest income will

A) increase desired saving because the expected after-tax real interest rate rises.

B) decrease desired saving because the expected after-tax real interest rate rises.

C) decrease desired saving because the expected after-tax real interest rate falls.

D) increase desired saving because the expected after-tax real interest rate falls.

12) If the substitution effect of the real interest rate on saving is larger than the income effect of the real interest rate on saving, then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving, for someone who's a lender.

A) fall; fall

B) fall; rise

C) rise; rise

D) rise; fall

13) If the substitution effect of the real interest rate on saving is smaller than the income effect of the real interest rate on saving, then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving, for someone who's a lender.

A) fall; fall

B) fall; rise

C) rise; rise

D) rise; fall

14) With a nominal interest rate of 4%, an expected inflation rate of 1%, and interest income taxed at a rate of 25%, what is the expected after-tax real interest rate?

A) 3%

B) 2%

C) 1%

D) 0%

15) The nominal interest rate is 10%, the expected inflation rate is 5%, and the combined state-federal tax rate is 35%. The expected after-tax real interest rate is

A) 1.50%.

B) 3.25%.

C) 5.00%.

D) 6.50%.

16) Three factors that cause interest rates among different financial instruments to vary are

A) default risk, expected inflation, and taxability.

B) default risk, current inflation, and taxability.

C) default risk, maturity, and taxability.

D) default risk, expected inflation, and maturity.

17) The yield curve generally slopes upward because

A) longer maturity bonds typically pay higher interest rates than shorter maturity bonds.

B) longer maturity bonds typically pay lower interest rates than shorter maturity bonds.

C) shorter maturity bonds have more default risk.

D) longer maturity bonds are not taxable.

18) If an investor has a tax rate on interest income of 25% and the inflation rate is 4%, which bond has the lowest expected after-tax real interest rate?

A) A Treasury bond paying 9%

B) A corporate bond paying 8%

C) A Treasury bond paying 7%

D) A municipal bond paying 6%

19) If an investor has a tax rate on interest income of 30% and the inflation rate is 4%, which bond has the highest expected after-tax real interest rate?

A) A Treasury bond paying 8%

B) A corporate bond paying 7%

C) A Treasury bond paying 7%

D) A municipal bond paying 6%

20) The yield curve shows

A) the yields on stocks of different maturities.

B) the interest rates on bonds of different maturities.

C) the yields on stocks with differing default risk.

D) the yields on bonds with differing default risk.

21) Desired national saving would increase unambiguously if there were

A) an increase in both current output and expected future output.

B) an increase in both expected future output and government purchases.

C) an increase in both expected future output and the expected real interest rate.

D) a fall in both government purchases and expected future output.

22) Desired national saving would decrease unambiguously if there were

A) a decrease in current output and a decrease in taxes.

B) an increase in expected future output and a decrease in government purchases.

C) an increase in both expected future output and the expected real interest rate.

D) a fall in both government purchases and expected future output.

23) The Ricardian equivalence proposition suggests that a government deficit caused by a tax cut

A) causes inflation.

B) causes a current account deficit.

C) raises interest rates.

D) doesn't affect consumption.

24) If the government cuts taxes today, issuing debt today and repaying the debt plus interest next year, a rational taxpayer will

A) spend the full amount of the tax cut today and reduce consumption next year.

B) increase consumption today, before taxes go up next year.

C) increase saving today, leaving consumption unchanged.

D) leave a smaller gross bequest to her or his heirs.

25) Which of the factors listed below might cause the Ricardian equivalence proposition to be violated?

A) There may be international capital inflows and outflows.

B) Consumers may not understand that an increase in government borrowing today is likely to lead to higher future taxes.

C) There may be constraints on the level of government spending.

D) There may be constraints on the level of government taxation.

4.2 Investment

1) The user cost of capital is given by the following formula, where

is the real price of capital goods, *d* is the depreciation rate, and r is the expected real interest rate.

A) *uc = (r + d)*/

B) *uc* =

/*(r + d)*

C) *uc = d*

/*r*

D) *uc = (r + d*)

2) Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a 25% rate, machine B costs $10,000 and depreciates at a rate of 20%, machine C costs $20,000 and depreciates at a rate of 10%, and machine D costs $17,000 and depreciates at a rate of 11%. The expected real interest rate is 5%.

A) Machine A

B) Machine B

C) Machine C

D) Machine D

3) Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a rate of 25%, machine B costs $10,000 and depreciates at a rate of 20%, machine C costs $20,000 and depreciates at a rate of 10%, and machine D costs $17,000 and depreciates at a rate of 11%. The expected real interest rate is 0%.

A) Machine A

B) Machine B

C) Machine C

D) Machine D

4) Calculate the user cost of capital of a machine that costs $5,000 and depreciates at a rate of 25%, when the expected real interest rate is 5%.

A) $150

B) $500

C) $1500

D) $5000

5) Calculate the user cost of capital of a machine that costs $5,000 and depreciates at a rate of 25%, when the nominal interest rate is 10% and the expected inflation rate is 5%.

A) $150

B) $500

C) $1500

D) $5000

6) Calculate the user cost of capital of a machine that costs $100,000 and depreciates at a rate of 25%, when the nominal interest rate is 4% and the expected inflation rate is 1%.

A) $3,000

B) $25,000

C) $28,000

D) $29,000

7) Calculate the user cost of capital of a machine that costs $5,000 and depreciates at a 25% rate, when the nominal interest rate is 5% and the expected inflation rate is 10%.

A) $5,000

B) $1500

C) $1000

D) $100

8) You are trying to figure out how much capacity to add to your factory. You will increase capacity as long as

A) the expected marginal product of capital is positive.

B) the expected marginal product of capital is greater than or equal to the marginal product of capital.

C) the expected marginal product of capital is greater than or equal to the expected marginal product of labor.

D) the expected marginal product of capital is greater than or equal to the user cost of capital.

9) When a company must consider taxes in determining investment, its desired capital stock is chosen such that

A) *MPKf = uc*(1-*t*)

B) *MPKf = uc*/(1-*t*)

C) *MPKf = t *× *uc*

D) *t *× *MPKf = uc*

10) The desired level of the capital stock will increase if the

A) user cost of capital increases.

B) expected future marginal product of capital increases.

C) effective tax rate increases.

D) price of capital increases.

11) An increase in the expected real interest rate will

A) increase the desired capital stock.

B) decrease the desired capital stock.

C) have no effect on the desired capital stock.

D) have the same effect on the desired capital stock as a decrease in corporate taxes.

12) If the rate of depreciation increases, then user cost ________ and the desired capital stock ________.

A) falls; falls

B) falls; rises

C) rises; rises

D) rises; falls

13) The relationship between stock prices and firms' investments in physical capital is captured by what theory?

A) User-cost-of-capital theory

B) *q* theory

C) Yield-curve theory

D) Keynesian theory

14) Tobin's *q* is equal to

A) the ratio of capital's market value to its replacement cost.

B) the ratio of capital's replacement cost to its market value.

C) the expected after-tax real interest rate.

D) the stock market value of a firm.

15) If the stock market value of a firm is $10 million and the firm owns $15 million of capital, then Tobin's *q* equals

A) 2/3.

B) 1.

C) 3/2.

D) 4.

16) A firm should invest more if Tobin's *q*

A) equals zero.

B) is less than one.

C) equals one.

D) is more than one.

17) A technological improvement will

A) increase the desired capital stock.

B) decrease the desired capital stock.

C) have no effect on the desired capital stock.

D) have the same effect on the desired capital stock as an increase in corporate taxes.

18) Suppose your company is in equilibrium, with its capital stock at its desired level. A permanent decline in the expected real interest rate now has what effect on your desired capital stock?

A) Raises it, because the future marginal productivity of capital is higher

B) Lowers it, because the future marginal productivity of capital is lower

C) Raises it, because the user cost of capital is now lower

D) Lowers it, because the user cost of capital is now higher

19) Suppose your company is in equilibrium, with its capital stock at its desired level. A permanent increase in the depreciation rate now has what effect on your desired capital stock?

A) Raises it, because the future marginal productivity of capital is higher

B) Lowers it, because the future marginal productivity of capital is lower

C) Raises it, because the user cost of capital is now lower

D) Lowers it, because the user cost of capital is now higher

20) Calculate the tax-adjusted user cost of capital of a machine that costs $10,000 and depreciates at a rate of 10%, when the real interest rate is 3% and the tax rate on revenue is 5%.

A) $1238

B) $1300

C) $1368

D) $1800

21) Cummins, Hubbard, and Hassett studied the effects of taxes on investment by

A) seeing if investment spending is correlated with taxes on investment.

B) examining what happened to investment when major tax reforms took place.

C) raising tax rates on certain businesses and testing their reaction.

D) raising tax rates on equipment and reducing tax rates on structures.

22) Cummins, Hubbard, and Hassett found that investment responded to a tax change that affected the user cost of capital, with an elasticity of

A) 0.

B) -0.25.

C) -0.66.

D) -1.

23) What is the difference between gross investment and net investment?

A) Net investment = gross investment minus taxes

B) Net investment = gross investment minus net factor payments

C) Net investment = gross investment minus inventory accumulation

D) Net investment = gross investment minus depreciation

24) At the start of the year, your firm's capital stock equaled $100 million, and at the end of the year it equaled $105 million. The average depreciation rate on your capital stock is 20%. Gross investment during the year equaled

A) $1 million.

B) $5 million.

C) $7 million.

D) $25 million.

25) At the start of the year, your firm's capital stock equaled $10 million, and at the end of the year it equaled $15 million. The average depreciation rate on your capital stock is 20%. Net investment during the year equaled

A) $3 million.

B) $4 million.

C) $5 million.

D) $7 million.

26) Your firm has capital stock of $10 million and a depreciation rate of 15%. Gross investment is $3 million. How much is net investment?

A) $1.5 million

B) $2.0 million

C) $2.5 million

D) $3.5 million

27) You have just purchased a home that cost $250,000. The nominal mortgage interest rate is 8% per annum, mortgage interest payments are tax deductible, and you are in a 30% tax bracket. The expected inflation rate is 4%. Maintenance and other expenses are 8% of the initial value of the house. What is the real user cost of your house?

A) $20,000

B) $24,000

C) $27,000

D) $30,000

4.3 Goods Market Equilibrium

1) When desired national saving equals desired national investment (in a closed economy), what market is in equilibrium?

A) The goods market

B) The money market

C) The foreign exchange market

D) The stock market

2) In the goods market equilibrium condition for a closed economy, the total demand for goods equals

A)

+

B)

+

+ *G*

C)

+

- *G*

D)

+ *G* -

3) An economy has full-employment output of 5000. Government purchases are 1000. Desired consumption and desired investment are given by

= 3000 - 2000*r* + 0.10*Y*

= 1000 - 4000*r*

where *Y* is output and r is the real interest rate. The real interest rate that clears the goods market is equal to

A) 1.25%.

B) 2.50%.

C) 8.33%.

D) 25.00%.

4) An economy has government purchases of 1000. Desired national saving and desired investment are given by

= 200 + 5000*r* + 0.10*Y* - 0.20*G*

= 1000 - 4000*r*

When the full-employment level of output equals 5000, then the real interest rate that clears the goods market will be

A) 1.11%.

B) 5.56%.

C) 16.67%.

D) 21.11%.

Diff: 3

5) An economy has government purchases of 2000. Desired national saving and desired investment are given by

= 200 + 5000*r* + 0.10*Y* - 0.20*G*

= 1000 - 4000*r*

When the full-employment level of output equals 5000, then the level of investment when the goods market is in equilibrium will be

A) 66.8.

B) 422.4.

C) 600.0.

D) 688.9.

6) Any change in the economy that raises desired national saving for a given value of the real interest rate will shift the desired national saving curve to

A) the right and increase the real interest rate.

B) the right and decrease the real interest rate.

C) the left and increase the real interest rate.

D) the left and decrease the real interest rate.

7) An increase in the expected real interest rate tends to

A) raise desired saving only.

B) raise desired investment only.

C) raise both desired saving and desired investment.

D) raise desired saving, but lower desired investment.

8) The saving-investment diagram shows that a higher real interest rate due to a leftward shift of the saving curve

A) raises the profitability of investment for firms.

B) causes the amount of firms' investment to increase.

C) increases the total amount of saving because of the increase in the real interest rate.

D) causes the total amounts of saving and investment to fall.

9) A temporary decrease in government purchases would cause

A) a rightward shift in the saving curve and a leftward shift in the investment curve.

B) a rightward shift in the saving curve and a rightward shift in the investment curve.

C) a rightward shift in the saving curve, but no shift in the investment curve.

D) no shift in the saving curve, but a leftward shift in the investment curve.

10) A temporary supply shock, such as a one month decrease in oil prices, would

A) increase the marginal product of capital and increase desired investment, increasing the real interest rate in equilibrium.

B) decrease the marginal product of capital and decrease desired investment, decreasing the real interest rate in equilibrium.

C) have little or no effect on desired investment, thus not changing the real interest rate by much in equilibrium.

D) increase both the marginal product of capital and the marginal product of labor in the long-term future, thus raising the real interest rate in equilibrium.

11) If consumers foresee future taxes completely, a reduction in taxes this year that is accompanied by an offsetting increase in future taxes would cause

A) a rightward shift in the saving curve and a rightward shift in the investment curve.

B) a shift in neither the saving nor the investment curve.

C) a leftward shift in the saving curve, but no shift in the investment curve.

D) no shift in the saving curve, but a rightward shift in the investment curve.

12) An invention that raises the future marginal product of capital (in a closed economy) would cause an increase in desired investment, which would cause the investment curve to shift to the ________ and would cause the real interest rate to ________.

A) right; increase

B) right; decrease

C) left; increase

D) left; decrease

13) A temporary supply shock, such as a drought, would

A) increase the marginal product of capital and increase desired investment.

B) decrease the marginal product of capital and decrease desired investment.

C) have little or no effect on desired investment.

D) decrease both the marginal product of capital and the marginal product of labor in the long-term future.

14) If the government reduces the effective tax rate on capital (in a closed economy), then the real interest rate ________ and saving ________.

A) falls; declines

B) falls; increases

C) rises; increases

D) rises; declines

15) If the stock market booms and people feel wealthier (in a closed economy), then the real interest rate ________ and investment ________.

A) falls; declines

B) falls; increases

C) rises; increases

D) rises; declines

16) Onerous regulations on businesses that take effect next year (in a closed economy)reduce businesses' expected future marginal product of capital. As a result, the real interest rate ________ and saving ________.

A) falls; declines

B) falls; increases

C) rises; increases

D) rises; declines

17) If consumers believe that next year a recession will occur (in a closed economy), then the real interest rate ________ and investment ________.

A) falls; declines

B) falls; increases

C) rises; increases

D) rises; declines

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