Macroeconomics - Chapter 10

Front 1

1. In most major countries, including Japan, Canada, and the US, fluctuations in
consumption are
a) countercyclical and more volatile than GDP
b) countercyclical and less volatile than GDP
c) procyclical and more volatile than GDP
d) procyclical and less volatile than GDP
e) unrelated to fluctuations in GDP

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d) procyclical and less volatile than GDP

Front 2

2. The marginal propensity to consume was conceived which famous economist?
a) Adam Smith
b) David Ricardo
c) Thomas Robert Malthus
d) John Maynard Keynes
e) Robert Solow

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d) John Maynard Keynes

Front 3

3. A graphical plot of consumption expenditures against disposable income for the US over
the past 20 years shows
a) no apparent relationship between consumption and disposable income
b) consumption remaining roughly constant as disposable income rises
c) consumption falling as disposable income rises
d) consumption rising as disposable income has fallen
e) consumption rising almost proportionately as income rises

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e) consumption rising almost proportionately as income rises

Front 4

4. The marginal propensity to consume is
a) consumption divided by disposable income
b) national income divided by consumption
c) the change in national income caused by a $1 change in consumption
d) the change in consumption caused by a $1 change in disposable income
e) the percentage increase in consumption caused by a 1% decrease in savings

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d) the change in consumption caused by a $1 change in disposable income

Front 5

5. The marginal propensity to consume is
a) identical to the average propensity to consume
b) the inverse of the marginal propensity to save
c) the slope of the consumption function
d) the inverse of the expenditure multiplier
e) equal to the income tax rate

Back 5

c) the slope of the consumption function

Front 6

6. The expenditure multiplier
a) is defined as the inverse of the savings rate
b) is greater than zero but less than one
c) does not depend on consumption behavior
d) is larger in a country with a large MPC than in a country with a small MPC
e) determines the effect on consumption from an increase in disposable income

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d) is larger in a country with a large MPC than in a country with a small MPC

Front 7

7. If the consumption function is C = 750 + .75Y and there are no income taxes, then the
expenditure multiplier is
a) .75
b) .25
c) 4.0
d) 3.0
e) 1,000

Back 7

c) 4.0

Front 8

Suppose C = 1000 + .9Y, G = 400, I = 100, (X – IM) = 0, and there are no income taxes.

8. The equilibrium level of national income is
a) 15,000
b) 13,500
c) 1,500
d) 5,000
e) 4,500

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a) 15,000

Front 9

Suppose C = 1000 + .9Y, G = 400, I = 100, (X – IM) = 0, and there are no income taxes.

9. If government purchases increase by 100, equilibrium GDP will
a) rise by 25%
b) rise by a factor of 10
c) rise by 90
d) rise by 100
e) rise by 1,000

Back 9

e) rise by 1,000

Front 10

Suppose C = 1000 + .9Y, G = 400, I = 100, (X – IM) = 0, and there are no income taxes.

10. If investment falls by 50, equilibrium GDP will
a) fall by 50
b) fall by 5
c) fall by 500
d) fall by 45
e) fall by half its previous value

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c) fall by 500

Front 11

11. According to the simple Keynesian model, if disposable income rises,
a) the marginal propensity to consume rises
b) savings falls
c) consumption increases
d) the expenditure multiplier rises
e) all of the above

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c) consumption increases

Front 12

12. The Keynesian cross model attributes differences between actual output and planned
expenditure to
a) unintended inventory accumulation or depletion
b) buffer stocks resulting from risk-averse decision-making regarding production
c) taxes
d) net exports
e) the diminishing marginal product of capital

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a) unintended inventory accumulation or depletion

Front 13

An individual is endowed with $100 of income in period 1, and will receive an income of 121
in period 2. The interest rate is 10%, and there are only 2 periods.

13. The maximum first period consumption consistent with the intertemporal budget
constraint is
a) 100
b) 110
c) 121
d) 210
e) 221

Back 13

d) 210

Front 14

An individual is endowed with $100 of income in period 1, and will receive an income of 121
in period 2. The interest rate is 10%, and there are only 2 periods.

14. The maximum second period consumption is
a) 100
b) 121
c) 221
d) 231
e) 233.1

Back 14

d) 231

Front 15

An individual is endowed with $100 of income in period 1, and will receive an income of 121
in period 2. The interest rate is 10%, and there are only 2 periods.

15. If first period consumption is $80, then second period consumption must be
a) 129
b) 131
c) 141
d) 143
e) 201

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d) 143

Front 16

An individual is endowed with $100 of income in period 1, and will receive an income of 121
in period 2. The interest rate is 10%, and there are only 2 periods.


16. In order to have the same level of consumption in both periods, each period’s
consumption must be
a) 80
b) 100
c) 110
d) 110.5
e) 121

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c) 110

Front 17

17. An indifference curve shows
a) different combinations of income and prices at which an individual can afford equal
quantities of two goods
b) different combination of goods that all cost the same
c) different quantities of current and future consumption that are consistent with the
intertemporal budget constraint
d) different combinations of goods that yield the same level of satisfaction
e) different levels of satisfaction that can be obtained from a given budget constraint

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d) different combinations of goods that yield the same level of satisfaction

Front 18

18. The slope of an indifference curve defined over current and future consumption
a) is constant
b) is equal to the rate of interest
c) indicates the consumer’s rate of time preference, or impatience
d) is flatter when the curve is farther away from the origin than when it is near the origin
e) is undefined

Back 18

c) indicates the consumer’s rate of time preference, or impatience

Front 19

Current income is 300, expected future income is 363, and the interest rate is 10%.

19. If consumption is to be the same in each period, each period’s consumption must be
a) 330
b) 300
c) 331.5
d) 333
e) 363

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a) 330

Front 20

Current income is 300, expected future income is 363, and the interest rate is 10%.

20. If current income rises to 363 and consumption is smoothed across periods, then
consumption in each period becomes
a) 326.7
b) 363
c) 399.3
d) 350
e) 371

Back 20

b) 363

Front 21

Current income is 300, expected future income is 363, and the interest rate is 10%.

21. If current income remains 300, while expected future income rises by $63, then
maintaining equal consumption across time requires consumption to be
a) 330
b) 340
c) 350
d) 360
e) 370

Back 21

d) 360

Front 22

Current income is 300, expected future income is 363, and the interest rate is 10%.

22. If income rises by $63 in each period, so Y(1) = 363 and Y(2) = 426, then in each period
consumption
a) also rises by $63
b) becomes 390
c) rises by $56.7, or 90% of $63
d) remains constant
e) rises by $126

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a) also rises by $63

Front 23

23. According to the permanent income hypothesis,
a) consumption responds only to changes in current income
b) consumption responds more to expected future changes in income than to current
income
c) consumption responds more to temporary changes in income than to permanent
changes
d) consumption responds more to lifetime income than to current income
e) consumption is a function of previous income

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d) consumption responds more to lifetime income than to current income

Front 24

24. According to the permanent income hypothesis, which of the following should raise
current consumption the most?
a) a lottery prize of $1,000
b) an unexpected year-end bonus of $1,000
c) a temporary tax cut of $1,000
d) an increase of $1,000 in annual salary
e) an inheritance of $1,000

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d) an increase of $1,000 in annual salary

Front 25

25. Which of the following is least likely to induce precautionary saving?
a) the decision to retire from work at age 62
b) the possibility of being laid-off from work ) the uncertainty of one’s lifetime
d) the risk of becoming ill
e) the prospect of a potentially large tax increase in the future

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a) the decision to retire from work at age 62

Front 26

26. An entrepreneur with current income of $200,000 believes that her future income will
either fall to $100,000 or rise to $300,000 with equal probabilities. Her rate of time
preference is exactly offset by the interest rate. In the first of two periods, she spends
$178,000 and saves $22,000 for the second period. Her behavior illustrates
a) a marginal propensity to consume of .89
b) the permanent income hypothesis
c) precautionary saving
d) the bequest motive
e) a borrowing constraint

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c) precautionary saving

Front 27

27. Who among the following is likely to have the highest marginal propensity to consume
out of current income?
a) a rational consumer who intends to behave strictly according to the permanent income
hypothesis
b) a risk averse consumer facing a high degree of uncertainty
c) a low-income consumer facing borrowing constraints
d) a working age consumer looking forward to retirement
e) a wealthy parent who is currently accumulating funds to bequeath to his heirs

Back 27

c) a low-income consumer facing borrowing constraints

Front 28

28. The effect of an increase in interest rates on current consumption is
a) positive among borrowers if the income effect is dominant
b) positive among borrowers if the substitution effect is dominant
c) positive among savers if the income effect is dominant
d) positive among savers if the substitution effect is dominant
e) strongly positive in the aggregate consumption data

Back 28

c) positive among savers if the income effect is dominant

Front 29

29. The economy’s IS curve has a downward slope because
a) when output is too high, firms cut investment to reduce inventory
b) as income rises, consumption rises and saving falls
c) as interest rates rise, investment decreases
d) as uncertainty increases, saving rises and consumption falls
e) as government purchases rise, interest rates fall

Back 29

c) as interest rates rise, investment decreases

Front 30

30. If realized capital gains are counted as household savings, then the saving rate in the US
over the past 2 decades has
a) fallen sharply from 10% to nearly zero
b) hovered near zero and occasionally been negative
c) remained roughly steady at 10%
d) increased sharply
e) varied dramatically as the stock market has fluctuated

Back 30

c) remained roughly steady at 10%

Front 31

31. The marginal propensity to consume is difficult to estimate because
a) it depends on expectations of future income
b) it depends on perceptions regarding the permanence of changes in income
c) it depends on credit and borrowing constraints
d) it declines as uncertainty increases
e) all of the above

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e) all of the above

Front 32

Consider an individual who enters adulthood and the labor force at age 18, expects to work 5
years at a real income of $10,000 per year, anticipates earning a real income of $40,000 per
year from age 23 to 63, expects to retire with a $10,000 annual pension, and live until age 78.
Suppose the interest rate is zero, and the individual seeks perfectly smooth consumption
across his adult lifetime.

32. In the absence of borrowing constraints, then beginning at age 18, the individual should
consume
a) all of his income as he receives it each year
b) $10,000 every year
c) $20,000 every year
d) $30,000 every year
e) $25,000 every year

Back 32

d) $30,000 every year

Front 33

Consider an individual who enters adulthood and the labor force at age 18, expects to work 5
years at a real income of $10,000 per year, anticipates earning a real income of $40,000 per
year from age 23 to 63, expects to retire with a $10,000 annual pension, and live until age 78.
Suppose the interest rate is zero, and the individual seeks perfectly smooth consumption
across his adult lifetime.


33. If borrowing is precluded, then beginning at age 18, the individual will consume
a) $10,000 each year until age 23, then about $32,000 per year afterwards
b) $10,000 every year
c) all of his income as he receives it each year
d) $10,000 per year until age 23, then $25,000 per year afterwards
e) $25,000 every year

Back 33

a) $10,000 each year until age 23, then about $32,000 per year afterwards

Front 34

Consider an individual who enters adulthood and the labor force at age 18, expects to work 5
years at a real income of $10,000 per year, anticipates earning a real income of $40,000 per
year from age 23 to 63, expects to retire with a $10,000 annual pension, and live until age 78.
Suppose the interest rate is zero, and the individual seeks perfectly smooth consumption
across his adult lifetime.


34. Suppose there are no borrowing constraints but the individual wishes to leave a bequest of
$120,000 (after adjusting for inflation) to heirs. Then annual consumption should be
a) $12,000
b) $16,000
c) $20,000
d) $24,000
e) $28,000

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e) $28,000

Front 35

35. The life cycle model explains saving primarily as
a) a desire to leave a bequest to one’s heirs
b) a response to uncertainty regarding longevity
c) a response to high real interest rates
d) a response to employment and demographic changes over one’s lifetime
e) the result of under-estimating real wealth

Back 35

d) a response to employment and demographic changes over one’s lifetime

Front 36

36. The long run significance of investment is due to
a) its volatility
b) the importance of capital to economic growth
c) the effect of income on investment
d) the procyclical nature of investment
e) its ability to crowd-out government expenditures

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b) the importance of capital to economic growth

Front 37

37. Investment is important to the short run health of the economy because it
a) is the largest component of GDP
b) is countercyclical, and thus stabilizing
c) is highly volatile, and thus contributes largely to business cycles
d) can be easily controlled by government
e) is highly predictable, and thus useful for forecasting

Back 37

c) is highly volatile, and thus contributes largely to business cycles

Front 38

38. The useful economic life of a machine depends most importantly on
a) the depreciation rate
b) the interest rate
c) the tax rate
d) risk
e) the marginal revenue produced by the machine

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a) the depreciation rate

Front 39

39. If each unit of capital lasts an average of 25 years, then for an economy with a capital
stock worth 5 times the annual GDP, approximately what percentage of output must be
set aside to replace depreciation?
a) 5%
b) 10%
c) 20%
d) 25%
e) 30%

Back 39

c) 20%

Front 40

40. The measured capital stock in developed countries
a) overestimates real capital growth because capital prices have risen dramatically in
recent years
b) underestimates real capital growth because machines have become more
powerful and less expensive
c) overestimates real capital growth because the manpower needed to operate new
machines in greater than in previous years
d) underestimates real capital growth because it does not include financial investments
e) overestimates real capital growth because it includes government consumption
expenditures

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b) underestimates real capital growth because machines have become more
powerful and less expensive

Front 41

41. In recent years, Japan, Germany, the UK, and the US have financed most investments
a) from retained earnings
b) by borrowing from banks
c) by issuing bonds
d) by issuing new equity, or shares of stock
e) by using trade credit and capital transfers

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a) from retained earnings

Front 42

42. A firm that can afford to buy capital out of retained earnings without borrowing
a) is indifferent to interest rates
b) invests more as interest rates rise
c) invests less as interest rates rise
d) is indifferent to the marginal product of capital
e) has an increasing marginal product of capital

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c) invests less as interest rates rise

Front 43

43. Which of the following does not directly affect the optimal stock of capital?
a) the price of output
b) the marginal product of labor
c) the depreciation rate
d) the risk premium
e) taxes

Back 43

b) the marginal product of labor

Front 44

Consider the following production function for a delivery service.
Number of trucks: 0 1 2 3 4 5
Number of deliveries: 0 100 170 230 280 300

Each delivery generates $200 in gross revenue, and the tax rate is 10 percent on profits. Each
truck costs $11,000.

44. The optimal number of trucks is
a) 1
b) 2
c) 3
d) 4
e) 5

Back 44

c) 3

Front 45

Consider the following production function for a delivery service.
Number of trucks: 0 1 2 3 4 5
Number of deliveries: 0 100 170 230 280 300

Each delivery generates $200 in gross revenue, and the tax rate is 10 percent on profits. Each
truck costs $11,000.

45. The net (after tax) profit will be
a) $4,500
b) $8,100
c) $10,800
d) $11,700
e) $12,400

Back 45

d) $11,700

Front 46

46. A machine will generate after tax revenues of $1331 at the end of each year for 3 years,
after which it will be worthless. (Its scrap value will only cover the cost of its removal).
The interest rate available to the firm on risk-free bank accounts or bonds is 10 percent.
The machine is a worthwhile investment if its purchase price is less than
a) $3,993.00
b) $4,846.17
c) $3,310.00
d) $4,392.30
e) $3,630.00

Back 46

c) $3,310.00

Front 47

47. Which of the following would encourage greater investment in capital?
a) an increase in the corporate profits tax
b) greater uncertainty regarding the rate of return
c) an increase in the price of capital
d) a reduction in the rate of interest
e) an increase in the rate of depreciation or obsolescence

Back 47

d) a reduction in the rate of interest

Front 48

48. Which of the following would most likely discourage investment?
a) an increase in the selling price of a firm’s output
b) a reduction in the selling price of corporate stock
c) an increase in bond prices
d) a reduction in the rate of inflation
e) an increase in the optimal capital stock

Back 48

b) a reduction in the selling price of corporate stock

Front 49

49. A firm’s net investment will be negative if
a) the actual capital stock is less than the optimal capital stock
b) the rate of return on capital exceeds the market interest rate
c) the depreciation rate is less than the gross investment rate
d) gross investment is zero
e) its workforce is growing faster than its capital stock

Back 49

d) gross investment is zero

Front 50

50. Technological advances affect the net capital stock by
a) reducing the volatility of investment
b) inducing obsolescence
c) lowering the marginal product of capital
d) shrinking the gap between gross and net investment
e) raising the aggregate gearing of firms

Back 50

b) inducing obsolescence

Front 51

51. Which of the following is a definition of Tobin’s q?
a) the growth rate of the quantity of money
b) a firm’s optimal capital stock divided by its actual capital stock
c) the ratio of a firm’s stock market valuation to the value of its physical assets
d) the ratio: gross investment/net investment
e) the rate at which physical capital depreciates, plus the interest rate

Back 51

c) the ratio of a firm’s stock market valuation to the value of its physical assets

Front 52

52. A firm should continue to invest as long as the value of Tobin’s q is
a) negative
b) zero
c) a positive fraction
d) one
e) greater than one

Back 52

e) greater than one

Front 53

53. A publicly traded firm has 2.5 million shares of stock outstanding, with a current share
price of $30. The firm’s insurance agent estimates that the replacement cost of the firm’s
plant and equipment (and related capital assets) is $70 million. Tobin’s q is
a) 0.84
b) 1.07
c) 1.20
d) 2.33
e) 2.80

Back 53

b) 1.07

Front 54

54. According to Tobin’s q theory of investment,
a) when the stock market undervalues a company, the company should invest in capital
expansion
b) when a firm’s bond prices rise, the firm should sell off existing assets
c) borrowing funds by issuing bonds is always a less expensive way than issuing stock to
raise funds for investment
d) a firm should buy capital when its stock market valuation exceeds the
replacement cost of capital
e) firms should invest at a constant rate each month, a practice known as dollar-cost
averaging

Back 54

d) a firm should buy capital when its stock market valuation exceeds the
replacement cost of capital

Front 55

55. Tobin’s q may be interpreted as a measure of
a) the quantity of a firm’s output
b) the optimal quantity of output for a monopolist
c) the relative importance of bond financing to equity financing
d) the rate of return on capital divided by the cost of capital
e) the useful life of physical capital

Back 55

d) the rate of return on capital divided by the cost of capital

Front 56

A publicly traded firm has 4 million shares of stock outstanding, with a current share price of
$50. The value of its plant and equipment is $250 million. Its profit annually is $50 million.

56. The average rate of return on existing capital is
a) 5%
b) 10%
c) 15%
d) 20%
e) 25%

Back 56

d) 20%

Front 57

A publicly traded firm has 4 million shares of stock outstanding, with a current share price of
$50. The value of its plant and equipment is $250 million. Its profit annually is $50 million.

57. The average cost of capital is approximately
a) 5%
b) 10%
c) 15%
d) 20%
e) 25%

Back 57

e) 25%

Front 58

A publicly traded firm has 4 million shares of stock outstanding, with a current share price of
$50. The value of its plant and equipment is $250 million. Its profit annually is $50 million.

58. Tobin’s q for this firm is
a) 0.75
b) 0.80
c) 1.00
d) 1.20
e) 1.25

Back 58

b) 0.80

Front 59

A publicly traded firm has 4 million shares of stock outstanding, with a current share price of
$50. The value of its plant and equipment is $250 million. Its profit annually is $50 million.

59. This firm should
a) divest itself of some of its capital
b) issue more stock
c) continue to operate as it is
d) invest in new plant and equipment
e) issue bonds

Back 59

a) divest itself of some of its capital

Front 60

60. Empirical evidence suggests that the relationship between a firm’s investment and its
stock prices is
a) strongly negative
b) weakly negative
c) nonexistent; the two variables are independent
d) weakly positive
e) strongly positive

Back 60

d) weakly positive

Front 61

61. In the 1980s, one often-heard explanation for the low levels of net investment in the US
and UK was that
a) developed economies had no incentives for acquiring new capital
b) investment opportunities were limited because the already large capital stock was
inducing a low marginal product of capital
c) depreciation and obsolescence were so rapid that firms could barely keep up with
demands for replacing existing capital
d) stock market participants sought short-term capital gains from market
appreciations rather than long term dividends from investment
e) rapid price inflation was creating excessive investor uncertainty

Back 61

d) stock market participants sought short-term capital gains from market
appreciations rather than long term dividends from investment

Front 62

62. A company’s gearing is
a) the ratio of debt to overall assets
b) the ratio of stock market valuation to book value
c) the share price divided by corporate earnings
d) its stockholder’s equity
e) the ratio of taxes paid to the overall wage bill

Back 62

a) the ratio of debt to overall assets

Front 63

63. The link between corporate profits and investment
a) results from heavy reliance on internal financing
b) indicates that cash flow is probably the key variable driving investment
c) is the strongest empirical evidence of Tobin’s q
d) explains the persistent drop in investment that occurred throughout the 1990s
e) helps to keep investment fairly stable and countercyclical

Back 63

a) results from heavy reliance on internal financing

Front 64

64. To the extent that firms base investment decisions on current profits,
a) Tobin’s q theory is supported
b) investment spending tends to destabilize the economy
c) resources are efficiently allocated
d) the hypothesis that available cash flow drives investment is rejected
e) taxes, depreciation, and interest rates are irrelevant

Back 64

b) investment spending tends to destabilize the economy

Front 65

65. Which of the following explains why investment may be procyclical?
a) high installation costs for replacing, updating, and expanding the capital stock
b) simultaneous investment by firms in various industries throughout the economy
c) the correlation between current profits and investment expenditures
d) the basing of expectations on current conditions
e) all of the above

Back 65

e) all of the above

Front 66

66. In the Keynesian view, the volatility of investment is primarily due to
a) technological advancements
b) waves of productivity change
c) “creative destruction”: new industries destroying old ones
d) “animal spirits”: unpredictable episodes of optimism and pessimism
e) erratic monetary policy by the central bank

Back 66

d) “animal spirits”: unpredictable episodes of optimism and pessimism

Front 67

67. A firm is most likely to have a value of Tobin’s q that exceeds 1 if
a) it is privately held
b) it consistently allows depreciation to erode its stock of physical capital
c) it holds numerous copyrights
d) its optimal capital stock exceeds its actual capital stock
e) its gross investment exceeds its net investment

Back 67

c) it holds numerous copyrights