Explain why consumption is less volatile than investment. What ...

[mcmcdaniel]

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]

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

[mcmcdaniel]

Gracias!

[ASDFGJLO]

Excellent