Q: In the two-period consumption model, what is the maximum amount a consumer can consume in period 2 if they consume nothing in period 1?

$$C_{2,\text{max}} = (1 + r) Y_1$ + Y_2$

Question 1

In the basic model of the desired capital stock, at what point do firms maximize their profits with respect to capital?

Accepted Answer

Where the marginal product of capital (MPK^f) equals the user cost of capital (uc): $$MPK^f = uc$$

Question 2

Suppose the real interest rate $$r$$ increases. According to the user cost of capital formula $$uc = (r + d) p_K$$, what happens to the desired capital stock $$K^*$$?

Accepted Answer

The desired capital stock $$K^*$$ decreases because the user cost of capital increases

Question 3

If the effective tax rate on capital, $$\omega$$, increases, how does this affect the desired capital stock?

Accepted Answer

It decreases the desired capital stock because the after-tax return falls: $$MPK^f = \frac{uc}{1-\omega}$$

Question 4

Which of the following best describes the marginal propensity to consume (MPC)?

Accepted Answer

The fraction of an additional dollar of current income that is consumed: $$MPC = \frac{\Delta C_1$}{\Delta Y_1$}$$

Question 5

A consumer faces the intertemporal budget constraint $$C_1$$ + \frac{$$C_2$$}{1+r} = $$Y_1$$ + \frac{$$Y_2$$}{1+r}$$. If Y_1$ increases by a$, what happens to the budget line?

Accepted Answer

It shifts outward in a parallel fashion, increasing both maximum $$C_1$$ and $$C_2$$

Question 6

If the real interest rate $$r$$ rises, what is the substitution effect on current and future consumption?

Accepted Answer

Current consumption $$C_1$$ falls and future consumption $$C_2$$ rises

Question 7

According to the Ricardian equivalence proposition, what is the effect of a tax cut today, financed by government borrowing, on current consumption?

Accepted Answer

There is no effect on current consumption because households anticipate higher future taxes

Question 8

Which of the following would cause the saving curve $$S(r) to $$shift to the left in the goods market equilibrium diagram?

Accepted Answer

An increase in government spending $$G$$

Question 9

In the two-period consumption model, what is the maximum amount a consumer can consume in period 2 if they consume nothing in period 1?

Accepted Answer

$$C_{2,	ext{max}} = (1 + r) Y_1$ + Y_2$

Question 10

If the depreciation rate $$d$$ increases, what happens to the user cost of capital and the desired capital stock?

Accepted Answer

User cost of capital increases and desired capital stock decreases

Question 11

Which of the following best explains why the marginal effective tax rate (METR) on investment in Canada has fallen since 2000?

Accepted Answer

Reductions in federal and provincial corporate income taxes

Question 12

If the government increases $$G_1 by $$borrowing rather than raising taxes, what is the effect on private saving $$S_p^d$$ and government saving $$S_g$$?

Accepted Answer

Private saving increases and government saving decreases

Question 13

In the goods market equilibrium, what role does the real interest rate $$r$$ play?

Accepted Answer

It adjusts to equate desired saving and desired investment: $$S^d(r) = I^d(r)$$

Question 14

Suppose technological progress increases the expected marginal product of capital $$MPK^f. $$What happens to the investment curve and equilibrium real interest rate?

Accepted Answer

The investment curve shifts right and the equilibrium real interest rate rises

Question 15

If a consumer is initially a borrower and the real interest rate $$r$$ increases, what is the likely effect on their current consumption $$C_1^d$?

Accepted Answer

Current consumption $$C_1^d$ decreases due to both substitution and income effects

Question 16

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

Accepted Answer

All taxes are lump-sum and non-distortionary

Question 17

If the real price of capital goods $$p_K$$ rises, what is the effect on the user cost of capital and investment?

Accepted Answer

User cost of capital increases and investment decreases

Question 18

In the two-period model, what is the present value of wealth $$W if $$initial financial assets $$V = 0$$?

Accepted Answer

$$W = Y_1$ + \frac{Y_2$}{1+r}$$

Investment, Consumption-Savings Decision, Fiscal Policy, and Goods Market Equilibrium in Macroeconomics

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