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Macroeconomics, 3e (Williamson) Chapter 8 A Two-Period Model: The Consumption-Savings Decision and Credit Markets

1) Consumption smoothing refers to A) the tendency of all consumers to choose the same amount of current consumption. B) the tendency of consumers to seek a consumption path over time that is smoother than income. C) the tendency of consumers to seek an income path over time that is smoother than consumption. D) consumer's concerns about going heavily into debt. Answer: B

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2) Intertemporal decisions involve economic decisions A) made within a given period of time. B) made in between two periods of time. C) involving trade-offs across periods of time. D) that ignore concerns about the future. Answer:

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3) The simplest device to analyze dynamic decisions is a A) one-period model. B) two-period model. C) model that includes only the number of years of a typical consumer's lifetime. D) continuous time model. Answer: B

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4) We use a two-period model because A) the business cycle has two phases: contraction and recovery. B) it is the simplest dynamic model. C) we want to make a distinction between young and old households. D) this is the horizon of the politicians that formulate policy. Answer: B

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5) We limit ourselves to two periods in the intertemporal model of the business cycle because A) we need to concentrate on the two phases of the business cycle. B) we can assume that people can live two periods of, say, 30 years. C) this is all we need to emphasize the intertemporal trade-off. D) we need an even number of periods. Answer: C

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6) For all bonds to be indistinguishable, A) all consumers must never be expected to default on their debts. B) the government must guarantee all bonds. C) all consumers must be identical. D) they must be traded through financial intermediaries. Answer: A

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7) Savings in our model are A) durable consumption. B) non-durable consumption. C) postponed consumption. D) money.

Answer:

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8) A one-period bond is a promise to repay A)

1 units of goods in the second period. (1 + r ) B) r units of goods in the second period. C) (1 + r) units of goods in the second period. D) the original amount lent. Answer: C

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9) The consumer's lifetime budget constraint states that A) the present value of lifetime consumption must be equal to the present value of lifetime gross income. B) the present value of lifetime consumption must be equal to the present value of lifetime disposable income. C) the present value of lifetime consumption plus the present value of lifetime taxes to be paid must be equal to the present value of lifetime income. D) the present value of lifetime taxes to be paid by the consumer must be equal to the present value of government spending. Answer: B

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10) The endowment point is the consumption bundle in which A)

first-period consumption is equal to zero. B) second-period consumption is equal to zero. C) the consumer finds the most utility. D) consumption is equal to disposable income in each period. Answer: D

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11) The endowment point is the consumption bundle in which A) both consumptions are the same. B) current consumption equals current output less current government expenses. C) no savings occur. D) the interest rate equals zero. Answer: C

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12) At the endowment point, we have the property that A) c = c'. B) c = y - t.

C) y - t = y' - t'. D) y = y'.

Answer:

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13) If we represents a two-period consumer's lifetime wealth and r denotes the real rate of interest, the vertical (future consumption) intercept of the consumer's budget line is equal to A) we.

B)

(1 + r)we.

C)

we . (1 + r ) D) (1 + r ) . we Answer: B

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14) If we represents a two-period consumer's lifetime wealth and r denotes the real rate of interest, the horizontal (current consumption) intercept of the consumer's budget line is equal to A) we. B)

(1 + r)we. C) we . (1 + r ) D) (1 + r ) . we Answer: A

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15) If we represents a two-period consumer's lifetime wealth and r denotes the real rate of interest, the slope of the consumer's budget line is equal to A) r we. B) 1 . (1 + r ) C)

r . (1 + we) D)

- (1 + r). Answer: D

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16) If the interest rate increases, lifetime wealth (we) A) increases.

B)

stays constant. C) decreases.

D)

changes in an ambiguous way. Answer: C

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17) To assure a well-defined solution to the consumers' intertemporal choice problems, we must assume that consumers' preferences exhibit the properties that A) consumers are all identical and that more is always preferred to less. B) more is preferred to less and that consumers prefer diversity. C) consumers like diversity and that more is sometimes preferred to less. D) more is sometimes preferred to less and that first-period consumption and second-period consumption are both normal goods. Answer: B

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18) We assume that the representative consumer's preferences exhibit the properties that A) they are convex and that more is always preferred to less. B) more is always preferred to less and that each consumer has one strictly favorite period of time for consumption. C) each consumer has one strictly favorite period of time for consumption and that current and future consumption are both normal goods. D) current and future consumption are both normal goods and that the consumer likes diversity in his or her consumption bundle. Answer: D

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19) The property of diminishing marginal rate of substitution follows from the property that the indifference curves are A) downward sloping. B) upward sloping. C) bowed in toward the origin. D) bowed out from the origin. Answer: C

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20) For the consumer to be at an optimum, it must be the case that A) 1 (1 + r ) B)

MRSc,c' =

MRSc,c' = (1 + r) C)

MRTc,c' =

1 (1 + r ) D)

MRTc,c' = (1 + r) Answer: B

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21)

A consumer is a borrower if A) optimum current consumption is less than current disposable income. B) optimum current consumption is greater than current disposable income. C) future disposable income is greater than current disposable income. D) the consumer's indifference curves are relatively steep. Answer: B

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22) A consumer is a lender if A) optimum current consumption is less than current disposable income. B) optimum current consumption is greater than current disposable income. C) current disposable income is greater than future disposable income. D) the consumer's indifference curves are relatively flat. Answer: A

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23) For a borrower in a (c,c') graph, the optimal consumption bundle is A) to the left of the endowment point. B) to the right of the endowment point. C) on the endowment point. D) dependent on other factors. Answer: B

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24) For a lender in a (c,c') graph, the optimal consumption bundle is A)

to the left of the endowment point. B) to the right of the endowment point. C) on the endowment point. D) dependent on other factors. Answer: A

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25) For a household in a (c,c') graph, the optimal consumption bundle is A) to the left of the endowment point. B) to the right of the endowment point. C) on the endowment point. D) dependent on other factors. Answer: D

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26) An increase in first-period income results in A) an increase in first-period consumption, an increase in second-period consumption, and an increase in saving. B)

an increase in first-period consumption, a decrease in second-period consumption, and an increase in saving. C) a decrease in first-period consumption, an increase in second-period consumption, and an increase in saving. D) an increase in first-period consumption, an increase in second-period consumption, and a decrease in saving. Answer: A

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27) With higher future taxes A) current consumption declines. B) current consumption stays the same. C) current consumption increases. D) current consumption depends on other factors. Answer: A

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28) A temporary increase in income today leads to A) a small increase in current consumption. B) a large increase in current consumption. C) a small decrease in future consumption. D) a large decrease in future consumption. Answer: A

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29) A permanent increase in income today leads to A) a small increase in current consumption. B) a large increase in current consumption. C) a small decrease in future consumption. D) a large decrease in future consumption. Answer: B

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30) If current income increases as much as future income decreases A)

current consumption decreases. B) current consumption stays the same. C) current consumption increases. D) We do not know. Answer: C

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31) A good proxy for the flow of consumption services would be A) aggregate consumption. B) consumption of services and consumption of durables. C) consumption of durables and consumption of nondurables. D) consumption of nondurables and consumption of services. Answer: D

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32) In the data, which of the following is most volatile? A) real GDP B) consumption of durables

C) consumption of nondurables D) consumption of services Answer: B

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33) In the absence of a financial system, the two-period model without taxes predicts that A) consumption is more volatile that output. B) consumption is as volatile as output. C) consumption is less volatile than output. D) We do not know. Answer: B

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34) The two primary explanations for the excess volatility of consumption are A) consumers' limited life spans and credit market imperfections. B) credit market imperfections and changes in market prices. C) changes in market prices and distorting taxes. D) distorting taxes and consumers' limited life spans. Answer: B

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35) An increase in second-period income results in A) an increase in first-period consumption, an increase in second-period consumption, and an increase in saving. B) an increase in first-period consumption, a decrease in second-period consumption, and an increase in saving. C) a decrease in first-period consumption, an increase in second-period consumption, and an increase in saving. D) an increase in first-period consumption, an increase in second-period consumption, and a decrease in saving. Answer: D

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36)

The idea that a permanent increase in income causes a larger increase in consumption than a temporary change in income is called the A) Friedman-Lucas theory. B) permanent income hypothesis. C) Ricardian equivalence theorem. D) intertemporal substitution effect. Answer: B

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37) Permanent income is A) the minimum income obtained throughout lifetime. B) income that cannot be taxed. C) income that cannot be lent. D) the constant income corresponding to lifelong wealth. Answer: D

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38) Permanent income is not A)

proportional to life-long wealth. B) proportional to current consumption. C) proportional to the present value of life-long consumption. D) proportional to the present value of life-long income before taxes. Answer: D

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39) What raises permanent income? A) lower future taxes B) higher current taxes C) higher interest rates D) higher current consumption Answer: A

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40) A martingale has the property that A) it is inherently unpredictable. B) the best prediction of its value tomorrow is its value today. C) the best prediction of its future growth rate is its current growth rate. D) the best prediction of its value tomorrow can be computed by looking at its past behavior. Answer: B

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41) A change in the stock market is a good indicator of a change in A) current income. B) future income. C) wealth.

D)

the future growth rate of real GDP. Answer: C

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42) An increase in the real interest rate is an example of a A)

pure substitution effect. B) substitution effect and a positive income effect. C) substitution effect and a negative income effect. D) substitution effect and an income effect whose sign depends on whether the consumer is initially a borrower or a lender. Answer: D

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43) An increase in the real interest A) increases savings for both borrowers and lenders. B) increases savings for borrowers, but has an uncertain effect on the savings of lenders. C) increases savings for lenders, but has an uncertain effect on the savings of borrowers. D) has an uncertain effect on the savings of both borrowers and lenders. Answer: B

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44) For a lender, an increase in the real interest rate A) definitely reduces current consumption and increases future consumption. B)

reduces current consumption and has an uncertain effect on future consumption. C) has an uncertain effect on current consumption and increases future consumption. D) has an uncertain effect on both current and future consumption. Answer: C

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45) For a borrower, an increase in the real interest rate A) definitely reduces current consumption and increases future consumption. B) reduces current consumption and has an uncertain effect on future consumption. C) has an uncertain effect on current consumption and increases future consumption. D) has an uncertain effect on both current and future consumption. Answer: B

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46) The substitution effect of a change in the real interest rate is an example of A) an intratemporal substitution effect. B) an intertemporal substitution effect. C) an atemporal substitution effect. D) a temporary substitution effect. Answer: B

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47) In a two-period model, government spending is financed through A) taxes and transfer payments. B) taxes and issuing debt. C) taxes and redeeming debt. D) taxes only. Answer: B

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48) The government's present value budget constraint states that A)

taxes must equal government spending in each period. B) the present value of government spending must be equal to the present value of consumers' disposable incomes. C) the present value of government spending must be equal to the present value of taxes. D) the government may run deficits each and every year, as long as the deficits are sufficiently small. Answer: C

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49) For a competitive equilibrium in a two-period model, all of the following must be true except A) each consumer picks first- and second-period consumption given the real interest rate. B) there must be an equal number of borrowers and lenders. C) the government's present-value budget constraint holds. D) the credit market clears. Answer: B

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50) The Ricardian equivalence theorem implies that A) government debt policy must be handled correctly for the economy to prosper. B)

the amounts of government spending are neutral. C) an increase in government spending has no effect on the economy, as long as there is an equal change in taxes. D) the timing of taxes collected by the government is neutral. Answer: D

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51) If government spending is held constant and Ricardian equivalence holds, A) an increase in the government budget deficit is always matched by a reduction in private savings. B) an increase in government savings is always matched by an increase in the government budget deficit. C) an increase in government savings is always matched by an equal increase in private savings. D) an increase in government savings is always matched by an equal reduction in private savings. Answer: D

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52) The Ricardian Equivalence says A) whatever the level of government expenses, consumption is the same. B) whatever the timing of taxes, consumption is the same. C) higher government expenses reduce consumption. D) an increase in current consumption has to lead to a decrease in future consumption. Answer: B

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53)

According to the Ricardian Equivalence A) trade deficits do not matter. B) fiscal deficits do not matter. C) current account deficits do not matter. D) household deficits do not matter. Answer: B

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54) The Ricardian equivalence implies that A) the level of government spending has no impact. B) the level of taxes has no impact. C) the distribution of government expenses though time has no impact. D) the distribution of taxes through time has no impact. Answer: D

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55) An important reason why Ricardian equivalence may fail is if A) borrowing and lending are done through intermediaries.

B) government debt incurred today may not be paid off until after some current consumers are deceased. C) state and local governments also engage in debt finance. D) some consumers are borrowers, while other consumers are lenders. Answer: B

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56) The Ricardian Equivalence holds only if A) the government is altruistic. B) there are no credit constraints. C) the government runs deficits. D) the government runs surpluses. Answer: B

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57) Which condition would generate a violation of the Ricardian Equivalence? A) downward sloping labor supply curve B) underdeveloped credit markets C) inflationary monetary policy D) deflationary monetary policy Answer: B

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58) When different consumers pay different amounts of taxes, Ricardian equivalence may fail because A) alternative ways of collecting the same tax revenue can affect the distribution of income. B) consumers can become jealous of one another. C) such differences in taxes create credit market imperfections. D) higher taxes on more talented people may be politically popular. Answer: A

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59) Distorting taxes can invalidate Ricardian equivalence because A)

they confuse consumers about the need for government to repay its debt. B) alternative ways of collecting the same tax revenue produce different amounts of lost welfare. C) they are inferior to lump-sum taxes. D) they are more popular, politically, than lump-sum taxes. Answer: B

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60) The phenomenon that some consumers pay a higher interest rate when they borrow than the interest rate they receive when they lend is best described as an example of A) irrational behavior. B) a credit market imperfection. C) a vast banking conspiracy. D) the burden of public debt. Answer: B

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61) When there are credit-market imperfections, an increase in government debt may be advantageous because it A) discourages credit-constrained consumers from borrowing too much.

B) allows credit-constrained consumers to borrow more. C) eliminates the problems that cause credit-market imperfections. D) encourages more private saving. Answer: B

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62) Consumer choice theory predicts that, with identical consumers, fully-funded social security A) always makes all generations worse off. B) makes some generations better off, and cannot make any generation worse off. C) may make some generations worse off and cannot make any generation better off. D) may be Pareto improving. Answer: C

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63) In a fully-funded social security program A) the young pay for the benefits of the old. B) the young are forced to save for their own retirement. C)

the young have to buy bonds for the old. D) the young are forced to save for the retirement of the old. Answer: B

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64) Why do consumers benefit from pay-as-you-go social security? A) It keeps inflation in check as money is redistributed. B) It is a better way than taxes to finance the government. C) It forces people to save more than they would otherwise. D) With sufficiently high population growth, many young contribute to the benefits of the old. Answer: D

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65) Consumer choice theory predicts that, with identical consumers, pay-as-you-go social security A) always makes all generations worse off. B) makes some generations better off, and cannot make any generation worse off. C) may make some generations worse off and cannot make any generation better off. D)

may be Pareto improving. Answer: D

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66) Social security is most likely to present political problems when A) moving from pay-as-you-go to fully-funded and when population growth is low. B) moving from pay-as-you-go to fully-funded and when population growth is high. C) moving from fully-funded to pay-as-you-go and when population growth is low. D) moving from fully-funded to pay-as-you-go and when population growth is high. Answer: A

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