Chapter 16

Question 1

Marginal propensity to consume (MPC)

Answer 1

The increase in consumption resulting from a one-dollar increase in disposable income.

Question 2

Average propensity to consume (APc)

Answer 2

The ratio of consumption to income. C/Y

Question 3

Intertemporal budget constraint

Answer 3

The budget constraint applying to expenditure and income in more than one period of time.

Question 4

Discounting

Answer 4

The reduction in value of future expenditures and receipts, compared to current expenditures and receipts, resulting from the presence of a positive interest rate.

Question 5

Indifference curves

Answer 5

A graphical representation of preferences that shows different combinations of goods producing the same level of satisfaction.

Question 6

Marginal rate of substitution (MRS)

Answer 6

The rate at which a consumer is willing to give up some of one good in exchange for more of another; the slope of the indifference curve.

Question 7

Normal good

Answer 7

A good that a consumer demands in greater quantity when his or her income rises.

Question 8

Income effect

Answer 8

The change in consumption of a good resulting from a movement to a higher or lower indifference curve, holding the relative price constant.

Question 9

Substitution effect

Answer 9

The change in consumption of a good resulting from a movement along an indifference curve because of a change in the relative price.

Question 10

Borrowing constraint

Answer 10

A restriction on the amount a person can borrow from financial institutions, limiting that person’s ability to spend his or her future income today; also called a liquidity constraint.

Question 11

Life=cycle hypothesis

Answer 11

The theory of consumption that emphasizes the role of saving and borrowing as transferring resources from those times in life when income is high to those times in life when income is low, such as from working years to retirement.

Question 12

Precautionary saving

Answer 12

The extra saving that results from uncertainty regarding, for example, longevity or future income.

Question 13

Permanent-income hypothesis

Answer 13

The theory of consumption according to which people choose consumption based on their permanent income, and use saving and borrowing to smooth consumption in response to transitory variations in income.

Question 14

Permanent income

Answer 14

Income that people expect to persist into the future; normal income.

Question 15

Transitory income

Answer 15

Income that people do not expect to persist into the future; current income minus normal income.

Question 16

Random walk

Answer 16

The path followed by a variable whose changes over time are unpredictable.