Chapter 13: Saving and Consumption

Question 1

true or false: consumption is the largest component of GDP

Answer 1

true

Question 2

does buying a home count as consuption

Answer 2

no, it is investment

Question 3

what is the consumption function

describe the graph

Answer 3

it shows the relationship between consumption and income

the graph is upward sloping, low on left, high on right. Can or can’t be a straight line

Question 4

What is the
marginal propensity to consume

Answer 4

MPC = change in consumption / change in income

it is the ratio of the change in consumption to the change in income

if you spend all extra income immediately, you have a MPC of 1.

If you spend no extra income you have a MPC of 0

it is also the slope of the consumption function

Question 5

true or false: if you arent saving you are consuming, if you arent consuming you are saving

Answer 5

true

Question 6

true or false: paying down debt is considered saving

Answer 6

true

Question 7

what is dissaving

Answer 7

when your consumption exceed your income

Question 8

true or false: borrowing money and withdrawing from your savings considered saving

Answer 8

false: it is dissaving

Question 9

what is the rational rule for consumers

Answer 9

consume more today if the marginal benefit is greater than or equal to the marginal benefit of spending a dollar + interest in the future

Question 10

what is the underlying trade-off in the rational rule for consumers

Answer 10

the benefit of delaying consumption is the interest you earn, while the cost is that you have to wait to enjoy the consumption

Question 11

what is consumption smoothing

Answer 11

the idea that you should maintain a steady or smooth path for you consumption spending over time. Maintain a stable level of consumption even if your income fluctuates

Question 12

true or false: the timing of when you receive your income is not relevant to your consumption choices

Answer 12

true

Question 13

what is permanent income

Answer 13

it is your best estimate of your long-term average income

Question 14

what is the permanent income hypothesis

Answer 14

the idea that people choose how much to consume based on their permanent income rather than their current income

Question 15

True or false: the MPC in permanent change in income is high

Answer 15

true

Question 16

True or false: the MPC, when change in income is anticipated is 0

Answer 16

true

Question 17

There are limitations on the relationship between income and consumption. What are they

Answer 17

People can’t always borrow (credit constraints)

It is hard to make deliberate forward looking plans and stick too them

Question 18

what are hand-to-mouth consumers

Answer 18

consumers that live paycheck to paycheck

Question 19

hand to mouth spend their _____ income

consumption smoothers spend their ______ income

Answer 19

current

permanent

Question 20

what is the MPC of hand-to mouth consumers

Answer 20

1, since they spend their income as soon as they receive it

Question 21

Describe how
1. a temporary change in income
2. a permanent change in income
3. an anticipated increase in income
4. learning about a future change in income
5. forecasting consumption changes

affect consumption smoothers and hand-to-mouth consumers

what is the effect on the total economy

Answer 21

consumption smoothers
1. small increase in C (MPC > 0)
2. Large increase in C (MPC ≈ 1)
3. No Change (MPC = 0)
4. Large increase in C (MPC > 0)
5. Hard to forecast

Hand to mouth
1. Large increase in C (MPC ≈ 1)
2. Large increase in C (MPC ≈ 1)
3. Large increase in C (MPC ≈ 1)
4. No Change (MPC ≈ 0)
5. Forecast by looking at income changes

Effect on total consumption
1. intermediate increase in C (MPC > 0)
2. Large increase in C (MPC ≈ 1)
3. intermediate increase in C (MPC > 0)
4. intermediate increase in C (MPC > 0)
5. Difficult but not impossible to forecast

Question 22

when there is a shift in consumption which way does the graph shift in response to a increase or decrease

Answer 22

increase - up
decrease - down

Question 23

what are the 4 factors that shift consumption and how would they shift

Answer 23

real interest rates
- if rates are low, more consumption, shift up,
- if rates are high, less consumption, shift down

Expectations
- if optimistic, more consumption, shift up
- if pessimistic, less consumption, shift down

Taxes
- if higher taxes, less consumption, shift down
- if lower taxes, more consumption, shift up

Wealth
- more wealth, more consumption, shift up
- less wealth, less consumption, shift down

Question 24

there are four key motives that drive saving, what are they

Answer 24

1. changing income over life cycle (think, saving for retirement)
2. Changing needs over the life cycle (think, having kids)
3. Bequests (leave money for someone after death)
4. Precautionary Saving (rainy day fund)

Question 25

what is a stock and flow variables

Answer 25

stock: assets, debts, wealth (they accumulate over time, like water in a bathtub)

flow: Income, consumption, saving (they add or subtract from stock, like water flowing out of a faucet or down a drain