Gordon_Answers11e_ch15 - 166 Gordon Macroeconomics,...

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166 Gordon • Macroeconomics, Eleventh Edition ± Answers to Questions in Textbook 1. Historically, the economy moves along the long-run consumption schedule (Figure 15-4), for which consumption and saving are a relatively constant share of permanent income. Not everyone receives an income equal to his or her permanent income, however. Consequently, when we examine cross-sectional data, those people with actual incomes greater than their permanent incomes will tend to have a saving rate somewhat higher than the average (and the reverse is true for those with incomes below permanent levels). Because people with high incomes are more likely to be in the group with actual incomes in excess of permanent incomes, the saving rate tends to be higher for that group. 2. The PIH suggests that people base their spending patterns on long-term, average incomes. Permanent changes in income cause changes in consumption based on this average response (long-run marginal propensity to consume). Changes in actual income might be due to permanent or temporary changes. The latter will not cause changes in consumption unless the perception of permanent income changes. Thus, the change in consumption out of actual income (short-run marginal propensity to consume) is much smaller because part of that income is considered transitory. 3. Permanent income is not permanent. It is the consumer’s expected average income. This can change if events cause the consumer’s expectations to change. Passing the bar exam, being accepted into medical school, or receiving a promotion are events that would change an individual’s estimate of his or her permanent income. 4. The legislation that created the tax rebate guaranteed these rebates ten years into the future. The strong suggestion, therefore, was that the tax rebate could be considered permanent. However, in the absence of transitory income, an “adaptive expectations” model of permanent income would not immediately adjust its valuation of permanent income to reflect a permanent decline in taxes unless j = 1. 5. The theory assumes that individuals use assets to increase consumption over their expected life span. If an individual planned no bequests, some of that person’s assets would be consumed each year, until none remained at the end of the person’s life. This behavior would allow consumption to be higher and saving to be lower for any given level of income. 6. According to the LCH, workers save and retirees dissave. The overall household saving rate depends on the saving and consumption behavior of both groups. An increase in the proportion of the population that is retired raises total consumption relative to total income, thus causing the saving rate to decline. This effect on the saving rate could be offset by a number of means, including an increase in labor productivity that raises income per worker, an increase in the retirement age, or an increase in the number of working-age immigrants accepted into the country. 7.
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This note was uploaded on 09/04/2010 for the course ECON 311 taught by Professor Gordon during the Spring '08 term at Northwestern.

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Gordon_Answers11e_ch15 - 166 Gordon Macroeconomics,...

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