Question 1

In the two-period consumption-savings model, what does the intertemporal budget constraint represent?

Accepted Answer

The present value of lifetime consumption must equal the present value of lifetime income minus the present value of lifetime taxes.

Question 2

Suppose a consumer faces the following intertemporal budget constraint: $$c + \frac{c'}{1+r} = y + \frac{y'}{1+r}. If $$the real interest rate $$r$$ increases, what happens to the relative price of future consumption in terms of current consumption?

Accepted Answer

It decreases, making future consumption cheaper relative to current consumption.

Question 3

Which of the following best describes the substitution effect of an increase in the real interest rate for a lender in the two-period model?

Accepted Answer

The consumer substitutes future consumption for current consumption because future consumption becomes relatively cheaper.

Question 4

If a consumer receives a temporary increase in current income, what is the most likely effect on their saving behavior according to the two-period model?

Accepted Answer

The consumer will save most of the temporary income increase to smooth consumption over time.

Question 5

Consider a consumer whose preferences exhibit perfect complementarity between current and future consumption, such that $$c' = a c. If $$the real interest rate $$r$$ increases, what happens to the consumer's optimal consumption bundle?

Accepted Answer

There is no substitution effect; the ratio of future to current consumption remains constant.

Question 6

According to the Ricardian Equivalence Theorem, what is the effect of a decrease in current taxes, holding government spending constant, on the consumer's lifetime wealth?

Accepted Answer

Lifetime wealth remains unchanged because the present value of taxes does not change.

Question 7

Suppose the government increases current spending $$G$$ and finances it by issuing debt $$B. $$What is the present-value government budget constraint?

Accepted Answer

$$G + \frac{G'}{1+r} = T + \frac{T'}{1+r}$$

Question 8

During the COVID-19 pandemic, many households in Canada experienced a decrease in current income relative to future income. According to the two-period model, what is the expected effect on current consumption and saving?

Accepted Answer

Current consumption decreases and saving decreases.

Question 9

A consumer's current-period budget constraint with lump-sum taxes is given by $$c + s = y - t. If $$the consumer chooses to save $$s \u003e 0$$, what does this imply about their consumption relative to disposable income?

Accepted Answer

Current consumption is less than disposable income.

Question 10

If the substitution effect of an increase in the real interest rate outweighs the income effect for all consumers, what is the likely impact on aggregate saving in the economy?

Accepted Answer

Aggregate saving will increase.

Question 11

In the two-period model, what is the slope of the lifetime budget constraint in $$(c, c')$$ space?

Accepted Answer

$$-(1+r)$$

Question 12

Suppose a consumer is a borrower in the two-period model. If the real interest rate increases, what is the most likely effect on their current and future consumption?

Accepted Answer

Current consumption decreases and future consumption may rise or fall.

Question 13

Which of the following is a necessary condition for a credit market to result in a Pareto improvement in the two-period model?

Accepted Answer

No consumer can be worse off due to the existence of the credit market.

Question 14

If a consumer's indifference curve in $$(c, c')$$ space is convex and downward sloping, what does this imply about their preferences?

Accepted Answer

The consumer is willing to trade off current and future consumption, but values diversity.

Question 15

In the two-period model, what is the marginal rate of substitution (MRS) at the optimal consumption bundle?

Accepted Answer

$$MRS = (1+r)$$

Question 16

If the government increases current taxes $$T$$ but keeps government spending $$G$$ constant, what does Ricardian Equivalence predict about the effect on consumption?

Accepted Answer

Consumption will remain unchanged because the present value of taxes is unchanged.

Question 17

Which of the following is NOT a reason why Ricardian Equivalence may fail in practice?

Accepted Answer

Consumers always have perfect foresight about future taxes.

Question 18

Suppose a consumer's current income $$y$$ increases, with no change in future income $$y' or $$taxes. According to the two-period model, what is the expected effect on current and future consumption?

Accepted Answer

Both current and future consumption increase, but current consumption increases by less than the increase in income.

Question 19

In the two-period model, what is the effect of a permanent increase in both current and future income on the consumer's lifetime wealth and consumption?

Accepted Answer

Lifetime wealth and current consumption both increase more than with a temporary increase in income.

Question 20

If aggregate consumption of non-durables and services is smoother than aggregate income, but consumption of durables is more volatile, what does this suggest about consumer behavior?

Accepted Answer

Consumers treat durables more like investment than consumption.

A Two-Period Model: Consumption–Savings Decision and Credit Markets

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