Author Question: Explain why consumption is less volatile than investment. What will be an ideal ... (Read 61 times)

mcmcdaniel · **on:** Jun 30, 2018

Explain why consumption is less volatile than investment.

What will be an ideal response?

Question 2

Let: (1 ) Pt be the price of one unit of a market basket of goods (i.e., a composite commodity) in year t; (2 ) Pet + 1 be the expected price of one unit of a market basket of goods in year t + 1; (3 ) et + 1 be the expected rate of inflation between period t and t + 1; and (4 ) it be the one-year nominal interest rate. Suppose an individual borrows the equivalent of one unit of a composite commodity today. Given this information, which of the following expressions represents (i.e., is equal to) the real interest rate (rt)?

A) (1 + it)(Pet+1)/(Pt)
B) (1 + et+1)/(1 + it)
C) (1 + et+1)/(1 + it) - 1
D) (1 + it)(Pt)/(Pet+1) - 1
E) none of the above

katara · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

At most, we would observe a one-for-one relationship between output and consumption. This is not the case with investment. When Y increases and is viewed as permanent by firms, they may increase investment to maintain a given capital-sales ratio. If this ratio is, say, 2, an increase in sales and output of 100 would require that I increase by 200. So, I will change more than C.

Answer to Question 2

D