Question 1

Suppose a consumer faces the following intertemporal budget constraint: $$C_1$$ + \frac{$$C_2$$}{1+r} = $$Y_1$$ + \frac{$$Y_2$$}{1+r}$$. If the real interest rate r$ increases, what happens to the slope of the budget line in a $$($$C_1$$, $$C_2$$)$$ diagram?

Accepted Answer

The slope becomes steeper, indicating that current consumption becomes relatively more expensive.

Question 2

Given the two-period model, if a consumer receives a one-time increase in current income $$Y_1 by$$ $$a$$, what is the effect on the intertemporal budget constraint?

Accepted Answer

The budget line shifts outward in a parallel fashion.

Question 3

If the marginal propensity to consume (MPC) out of current income is less than 1, what does this imply about the consumer's behavior?

Accepted Answer

The consumer saves part of the additional income to increase future consumption.

Question 4

Consider a consumer with no initial financial assets ($$V=0). If$$ $$Y_1 = 100$, Y_2$ = 110$$, and $$r = 0.10$$, what is the present value of the consumer's wealth $$W$$?

Accepted Answer

$$W = 100 + \frac{110}{1.10} = 200$$

Question 5

Which of the following best describes the consumption-smoothing motive?

Accepted Answer

Consumers desire to have a relatively even pattern of consumption over time.

Question 6

If a consumer is initially a saver and the real interest rate increases, what is the likely effect on current consumption $$C_1$$ due to the substitution effect?

Accepted Answer

$$C_1$$ decreases because current consumption is now more expensive relative to future consumption.

Question 7

Suppose a consumer's utility function is $$U(C_1$, C_2$) = \bar{U}. If$$ $$C_1$$ increases while keeping utility constant, what must happen to $$C_2$$?

Accepted Answer

$$C_2$$ must decrease.

Question 8

If a consumer expects a permanent increase in income (both $$Y_1$$ and $$Y_2$$ increase), what is the likely effect on consumption in each period?

Accepted Answer

Consumption increases in both periods.

Question 9

A consumer's intertemporal budget constraint is $$C_1$$ + \frac{$$C_2$$}{1+r} = W$$. What does the term $$\frac{$$C_2$$}{1+r}$$ represent?

Accepted Answer

The present value of future consumption.

Question 10

If a consumer is initially a borrower and the real interest rate increases, what is the combined effect of the substitution and income effects on current consumption $$C_1$$?

Accepted Answer

$$C_1$$ decreases due to both effects.

Question 11

Suppose a consumer's current income $$Y_1$$ increases by $$a$$, but expected future income $$Y_2$$ remains unchanged. What happens to desired private saving $$S_p$$?

Accepted Answer

$$S_p$$ increases because part of the increase in $$Y_1 is $$saved.

Question 12

If the consumer's initial financial assets $$V$$ are positive, how does this affect the intertemporal budget constraint?

Accepted Answer

It increases the present value of wealth $$W$$ and shifts the budget line outward.

Question 13

Which of the following statements about indifference curves in the $$(C_1$, C_2$)$$ space is correct?

Accepted Answer

Indifference curves further from the origin represent higher utility levels.

Question 14

If a consumer's future income $$Y_2$$ increases by $$a$$, what is the effect on current desired consumption $$C_1^d$ and desired private saving S_p$?

Accepted Answer

$$C_1^d$ increases and S_p$ decreases.

Question 15

A consumer faces the following budget constraint: $$C_1$$ + \frac{$$C_2$$}{1+r} = W$$. If the consumer chooses to consume all wealth in the current period, what is the maximum C_1$ they can achieve?

Accepted Answer

$$C_1 = W$

Question 16

In the two-period model, what is the opportunity cost of consuming $$1 more in the current period (C_1$)?

Accepted Answer

The opportunity cost is $$(1+r)$$ units of future consumption ($$C_2).$$

Question 17

If the substitution effect of an increase in the real interest rate dominates for a saver, what happens to $$C_1^d$ and S_p$?

Accepted Answer

$$C_1^d$ decreases and S_p$ increases.

Question 18

Which of the following best describes the effect of a temporary increase in income on consumption and saving?

Accepted Answer

Most of the increase is saved and spread over future periods.

Question 19

If a consumer is a borrower and the real interest rate increases, what happens to their debt burden and optimal consumption profile?

Accepted Answer

Debt burden increases and current consumption decreases.

Consumption-Savings Decision in Macroeconomics: Theory and Applications

Study Guide - Practice Questions

Study Guide - Flashcards