ECO101H1 Chapter Notes - Chapter 8: Budget Constraint, Old Age Security, Consumption Smoothing

18 views3 pages

champagnetrout951

22 Jun 2016

School

Department

Course

Professor

For unlimited access to Textbook Notes, a Class+ subscription is required.

elizabethkandelaki and 40134 others unlocked

ECO101H1 Full Course Notes

Verified Note

98 documents

Document Summary

Interest rate tells us how much future consumption we can get by giving up a certain amount of current consumption. Principle + interest = relative price between present and future consumption. Present discounted value: to calculate and express how much in the future is worth today. The interest rate is r times 100; formula is 100/(1+r) < these calculations are called compound interest. Simple interest: does not take into account the interest you earn on interest you have previously earned. Present discounted value of an amount is much smaller than by adding up returns = undiscounted yield of the amount. Time value of money: decision make must be able to value money that will be received in one, two , n years in the future. Intertemporal trades: exchanges that occur over a period of time. Interest rate is determined by the law of supply and demand.

Related Questions

A consumer is making saving plans for this year and next. She knows that her real income after taxes will be $50,000 in both years. Any part of her income saved this year will earn a real interest rate of 10% between this year and next year. Currently, the consumer has no wealth (no money in the bank or other financial assets, and no debts). There is no uncertainty about the future.

The consumer wants to save an amount this year that will allow her to (1) make college tuition payments next year equal to $12,600 in real terms; (2) enjoy exactly the same amount of consumption this year and next year, not counting tuition payments as part of next year's consumption; and (3) have neither asserts nor debts at the end of next year.

a. How much should the consumer save this year? How much should she consume? How are the amounts that the consumer should save and consume affected by each of the following changes (taken one at a time, with other variables held at their original values)?

b. Her current income rises from $50,000 to $54,200.

c. The income she expects to receive next year rises from $50,000 to $54,200.

d. During the current year she receives an inheritance of $1050 (an increase in wealth, not income).

e. The expected tuition payment for next year rises from $12,600 to $14,700.

f. The real interest rate rises form 10% to 25%.

Finance and Monetary Policy: Use our standard Keynesian macroeconomic model:

Y = E = C + I + NX + G: GDP equals the sum of consumption, investment, net exports, and government purchases.

C = c0 + cy x Y: consumption equals the consumer-confidence term plus the mpc times GDP or income

I = I0 - Ir x r: Business investment spending equals the business animal-spirits term minus the interest sensitivity of investment times the long-run real risky interest rate.

Î¼ = 1/(1 - cy): The multiplier is the inverse of one minus the mic.

Y = Î¼(c0 + I0 + NX) - (Î¼ Ir) x r + Î¼G: Our summing-up equation, telling us how the level of annual GDP depends on the multiplier Î¼, on the private spending flows c0 + I0 + NX, on the interest-sensitivity parameter Ir, on the interest rate r, and on government purchases G

a) Suppose that the short-term safe nominal interest rate on government securities the Federal Reserve controls, i = 5%, the expected inflation rate = 2.5%, the term premium = -1%, and the risk premium = 3%. What is the real risky interest rate r at which banks lend to companies the rate that matters for investment spending?

b) Suppose that the expected inflation rate stays the same, but a financial crisis causes the risk premium to spike from 3% to 8%. What happens to the long-term risky real interest rate r if the term premium and the short-term safe interest rate on government securities 'i' remain constant?

c) Suppose that for each one-percentage-point the Federal Reserve reduces the interest rate it controls 'i', the term premium moves by 1/2 percentage point in the opposite direction. What happens to the long-term risky real interest rate r if the risk premium spikes from 3% to 8% and the Federal Reserve responds by lowering the short-term safe nominal interest rate 'i' it controls by as much as possible?

d) Suppose that the interest sensitivity of investment 'Ir' is $0.2T that a 1% point change in r moves annual investment spending I by $0.2T in the opposite direction. By how much downward pressure would the shift from the situation in (a) to the situation in (c) have put on investment spending?

e) With a multiplier Î¼ of 3, and holding other things constant, how much downward pressure on annual GDP Y would have been generated by the downward pressure on investment spending in (d)?

f) Suppose that the Federal Reserve had kept the 'i' it controls the same. How much downward pressure would the financial crisis and its interest rate spike have put on annual GDP Y?

g) Suppose the Federal Reserve took active, aggressive, and successful policy steps to convince people that it would keep the interest rate 'i' it controlled at zero for a long time into the future, and so had nailed the term premium to the value of 0. What would your answer to (f) have
been?

jadecoyote283

TRUE / FALSE

1. True False In the aggregate expenditures model presented in the textbook,

investment is assumed to rise with increases in real GDP and fall with decreases in real GDP.

2. True False When C + I_g = GDP in a private closed economy, S = I_g and there are no unplanned changes in inventories.

3. True False The risk-free interest rate is the rate on long-term U.S. government bonds.

4. True False Bond prices and interest rates are directly or positively related.

5. True False The public debt is the accumulation of all deficits and surpluses that have occurred through time.

6. True False The M₂ money supply may be larger or smaller than the M₁ money supply depending on the size of small-denominated time deposit balances and Money Market Mutual Fund balances held by individuals.

7. True False Excess reserves are the amount by which required reserves exceed actual reserves.

8. True False The public debt is held as Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds.

9. True False The equilibrium price level and equilibrium level of real GDP occur at the intersection of the aggregate demand curve and the aggregate supply curve.

10. True False Investment is highly stable; it increases over time at a very steady rate.

MULTIPLE CHOICE

11. A recessionary expenditure gap is:

A. the amount by which the full-employment GDP exceeds the level of aggregate expenditures.

B. the amount by which equilibrium GDP falls short of the full-employment GDP.

C. the amount by which investment exceeds saving at the full-employment GDP.

D. the amount by which aggregate expenditures exceed the full-employment level of GDP.

12. The multiplier effect indicates that:

A. a decline in the interest rate will cause a proportionately larger increase in investment.

B. a change in spending will change aggregate income by a larger amount.

C. a change in spending will increase aggregate income by the same amount.

D. an increase in total income will generate a larger change in aggregate expenditures.

13. Which one of the following is true about the U.S. Federal Reserve System?

There are 12 regional Federal Reserve Banks.

B. The head of the U.S. Treasury also chairs the Federal Reserve Board.

C. There are 14 members of the Federal Reserve Board.

D. The Open Market Committee is smaller in size than the Federal Reserve Board.

14. If the nominal interest rate is 18 percent and the real interest rate is 6 percent, the inflation rate is:

A. 18 percent.

B. 24 percent.

C. 12 percent.

D. 6 percent.

15.

Refer to the above diagram for a private closed economy. The equilibrium level of GDP is:

A. $400.

B. $300.

C. $200.

D. $100.

16. Which of the following represents the most expansionary fiscal policy?

A. a $10 billion tax cut

B. a $10 billion increase in government spending

C. a $10 billion tax increase

D. a $10 billion decrease in government spending

17.

Refer to the above table. The economy shown is a:

A. private economy.

B. private open economy.

C. mixed closed economy.

D. mixed open economy.

18. Currency held in the vault of First National Bank is:

A. counted as part of M₁.

B. counted as part of M₂, but not M₁.

C. only counted as part of M₁ if it was deposited into a checking account.

D. not counted as part of the money supply.

19. If the dollar appreciates relative to foreign currencies, we would expect:

A. the multiplier to decrease.

B. the country's exports and imports to both fall.

C. the country's net exports to rise.

D. the country's net exports to fall.

20. The most important determinant of consumption and saving is the:

A. level of bank credit.

B. level of income.

C. interest rate.

D. price level.

21. The multiple by which the commercial banking system can increase the supply of money on the basis of each dollar of excess reserves is equal to:

A. the reciprocal of the required reserve ratio.

B. 1 minus the required reserve ratio.

C. the reciprocal of the income velocity of money.

D. 1/MPS.

22. Which one of the following would not shift the aggregate demand curve?

A. a change in the price level

B. depreciation of the international value of the dollar

C. a decline in the interest rate at each possible price level

D. an increase in personal income tax rate

23. The cyclically-adjusted budget tells us:

A. that in a full-employment economy the Federal budget should be in balance.

B. that tax revenues should vary inversely with GDP.

C. what the size of the Federal budget deficit or surplus would be if the economy was at full

employment.

D. the actual budget deficit or surplus realized in any given year.

24. The aggregate supply curve:

A. is explained by the interest rate, real-balances, and foreign purchases effects.

B. gets steeper as the economy moves from the top of the curve to the bottom of the curve.

C. shows the various amounts of real output that businesses will produce at each price level.

D. is downsloping because real purchasing power increases as the price level falls.

25.

Refer to the above diagram. If the equilibrium price level is P₁, then:

A. aggregate demand is AD₂.

B. the equilibrium output level is Q₃.

C. the equilibrium output level is Q₂.

D. producers will supply output level Q₁

26. Discretionary fiscal policy refers to:

A. any change in government spending or taxes that destabilizes the economy.

B. the authority that the President has to change personal income tax rates.

C. intentional changes in taxes and government expenditures made by Congress to stabilize the economy.

D. the changes in taxes and transfers that occur as GDP changes.

27.

Refer to the above diagram. Which tax system has the most built-in stability?

A. T₄

B. T₃

C. T₂

D. T₁

28.

Refer to the given graph. A shift of the consumption schedule from C₁ to C₂ might be caused by a(n):

A.	recession.

B.	wealth effect of an increase in stock market prices.

C.	increase in income tax rates.

D.	increase in saving.

29. When a bank loan is repaid the supply of money:

A. is constant, but its composition will have changed.

B. is decreased.

C. is increased.

D. may either increase or decrease.

30. The Federal budget deficit is found by:

A. subtracting government tax revenues plus government borrowing from government spending in a particular year.

B. subtracting government tax revenues from government spending in a particular year.

C. cumulating the differences between government spending and tax revenues over all years since the nation's founding.

D. subtracting government revenues from the noninvestment-type government spending in a particular year.

31.

Refer to the above information. Money supply M₁ for this economy is:

A. $ 60.

B. $ 70.

C. $ 130.

D. $ 140.

32. Which of the following statements is true as a result of Federal Reserve efforts to rescue the financial industry from the financial crisis of 2007 and 2008?

From February 2008, to May 2009, the Fed oversaw the consolidation of 20 major financial institutions into fewer than a dozen.

B. From March 2008, to February 2009, the Fed experienced a 50 percent decline in the value of assets held.

C. From February 2008, to March 2009, Fed assets more than doubled to nearly $2 trillion.

D. From February 2008, to March 2009, Fed lending caused the U.S. public debt to rise by over $1 trillion.

33. Which of the following is the basic economic policy function of the Federal Reserve Banks?

holding the deposits or reserves of commercial banks

B. acting as fiscal agents for the Federal government

C. controlling the supply of money

D. the collection or clearing of checks among commercial banks

34. In a fractional reserve banking system:

A. bank panics cannot occur.

B. the monetary system must be backed by gold.

C. banks can create money through the lending process.

D. the Federal Reserve has no control over the amount of money in circulation.

35.

Refer to the diagram that applies to a private closed economy. The APC is equal to 1 at income level:

36. Assume the Continental National Bank's balance statement is as follows:

Assuming a legal reserve ratio of 20 percent, how much in excess reserves would this bank have after a check for $10,000 was drawn and cleared against it?

A. $ 3,000

B. $ 24,000

C. $ 6,000

D. $ 16,000

37. Answer the question on the basis of the following table for a commercial bank or thrift:

Refer to the above table. When the legal reserve ratio is 25 percent, the excess reserves of this single bank are:

A. $0.

B. $1,000.

C. $5,000.

D. $30,000.

38. Which of the following is a tool of monetary policy?

A. open market operations

B. changes in banking laws

C. changes in tax rates

D. changes in government spending

39. An increase in nominal GDP increases the demand for money because:

A. interest rates will rise.

B. more money is needed to finance a larger volume of transactions.

C. bond prices will fall.

D. the opportunity cost of holding money will decline.

40. Answer the next question on the basis of the following table:

At equilibrium in the above market for money, the total amount of money demanded is:

A. $500.

B. $480.

C. $460.

D. $440.

41. For most financial assets investors must be compensated for:

A. non-diversifiable and diversifiable risk.

B. diversifiable risk and time preference.

C. non-diversifiable risk and time preference.

D. non-diversifiable and diversifiable risk, and time preference.

42. Reserves must be deposited in the Federal Reserve Banks by:

A. only commercial banks which are members of the Federal Reserve System.

B. all depository institutions, that is, all commercial banks and thrift institutions.

C. state chartered commercial banks only.

D. federally chartered commercial banks only.

43.

Refer to the diagrams. Assuming a constant price level, an increase in aggregate expenditures from AE₁to AE₂ would:

A.	move the economy from A to C along AD₁.

B.	move the economy from C to A along AD₁.

C.	increase aggregate demand from AD₁ to AD₂.

D.	decrease aggregate demand from AD₂ to AD₁.

44. The discount rate is the interest:

A. rate at which the central banks lend to the U.S. Treasury.

B. rate at which the Federal Reserve Banks lend to commercial banks.

C. yield on long-term government bonds.

D. rate at which commercial banks lend to the public.

45. What concept describes how quickly an investment increases in value when interest is paid not only on the original amount invested, but also on the accumulated interest payments?

A. present value

B. future value

C. compound interest

D. real rate of interest

46. The aggregate demand curve:

A. is upsloping because a higher price level is necessary to make production profitable as production costs rise.

B. is downsloping because production costs decline as real output increases.

C. shows the amount of expenditures required to induce the production of each possible level of real output.

D. shows the amount of real output that will be purchased at each possible price level.

47. The Security Market Line depicts the relationship between the:

A. average expected rate of return on stocks and the average expected rate of return on bonds.

B. average expected rate of return of a financial asset and the discount rate.

C. risk level of a financial asset and the prime interest rate.

D. average expected rate of return and risk level of a financial asset.

48. Arbitrage causes all financial assets:

A. of the same risk level to have the same price.

B. to have the same expected rate of return.

C. to have the same beta.

D. of the same risk level to have the same average expected rate of return.

49.

Refer to the diagrams. The numbers in parentheses after the AD₁, AD₂, and AD₃ labels indicate the levels of investment spending associated with each curve. All figures are in billions. If the money supply is MS₁ and the goal of the monetary authorities is full-employment output Q_f, they should:

A.	increase the money supply from $80 to $100.

B.	increase the money supply from $80 to $120.

C.	maintain the money supply at $80.

D.	decrease the money supply from $80 to $60.

50. Given the expected rate of return on all possible investment opportunities in the economy:

A. an increase in the real rate of interest will reduce the level of investment.

B. a decrease in the real rate of interest will reduce the level of investment.

C. a change in the real interest rate will have no impact on the level of investment.

D. an increase in the real interest rate will increase the level of investment.

END OF THE EXAM

ECO101H1 Chapter Notes - Chapter 8: Budget Constraint, Old Age Security, Consumption Smoothing

ECO101H1 Full Course Notes

Document Summary

Get access

Related textbook solutions

Principles of Economics

Principles of Macroeconomics

Principles of Microeconomics

Related Documents

ECO101H1 Lecture Notes - Lecture 12: Normal Good, Real Interest Rate, Loanable Funds

ECO101H1 Chapter Notes - Chapter 7: Marginal Revenue, Capital Accumulation, Marginal Product

FIN 300 Chapter Notes - Chapter 5: Investment, Interest, Discounting

Related Questions