Chapter 15 - Expectations, Consumption, and Investment

Question 1

Milton Friedman

Answer 1

permanent income theory of consumption

Question 2

Modigliani

Answer 2

life cycle theory of consumption

Question 3

consumption smoothing;

Answer 3

if you want to consume the same amount every year, the constant level of consumption that you can afford equals your total wealth divided by your expected remaining life

Question 4

key assumption for consumption smoothing

Answer 4

no borrowing constraints

Question 5

expectations affect consumption

Answer 5

directly through human wealth

indirectly through nonhuman wealth

Question 6

Implications of expectations for the relation between consumption and income

Answer 6

consumption is likely to respond less than one-for-one to current income shocks
consumption may move even if current income does not change

Question 7

Investment under static expectations:

Answer 7

• investment depends on the ratio of profit to the user cost
• the higher the profit, the higher the level of investment
• the higher the user cost, the lower the level of investment

Question 8

under static expectations: if a firm’s current profit is low:

Answer 8

• it can get funds for new machines only by borrowing

- might have difficulty borrowing