Problem Set 5 302 Solution 2012WT1 - Econ 302 Fall 2012 Problem Set 5 Please Print and Answer in the Provided Space(1 Using consumption smoothing theory

Problem Set 5 302 Solution 2012WT1 - Econ 302 Fall 2012...

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Econ 302 Fall 2012 Problem Set 5 Please Print and Answer in the Provided Space (1) Using consumption smoothing theory, rank the following from the biggest to the smallest consumption increase among recipients. (For simplicity you can assume that consumers’ desired consumption plan is equal consumption over their life-cycle). (a) an unexpected and explicitly temporary tax rebate of $300. (b) a special Google dividend of $300 per shareholder, that also lowers the value of the stock by $300 per shareholder. (c) an unexpected raise of $300 per year, effective immediately. The ranking is (c) > (a) > (b) In (c) there is no need to spread the increase over time, because consumers receive this increase every year. (In this case MPC=1) In (a) consumers want to smooth the additional one-time increase in income. If we assume that consumers desire equal consumption, then we can also say that MPC = 1/X (where X is the number of periods we plan ahead). In (b) nothing happens to our expected wealth. While we get more income today, the value of our assets is going down by the exact same value. That means that there is no change in PVLR.