Chapter 15, Problem 1QAP

a)

To determine

The validity of the statement that there would not be a big difference between human wealth and nonhuman wealth to a college student.

Answer to Problem 1QAP

False

Explanation of Solution

The statement could be considered as false. In relation to a college student, human and nonhuman wealth are not the same. A college student would not own any nonhuman wealth as it is the sum of financial wealth and housing wealth. Nevertheless, the human wealth possessed by a college student would be high. For example, his future income streams being adjusted for income tax.

Economics Concept Introduction

Introduction:Human wealth could be defined as the wealth that could be earned as a result of being a human. For example income. Nonhuman wealth refers to aspects such as financial wealth and housing wealth. Although similar, these two are much different concepts.

b)

To determine

The validity of the statement that natural experiments are not in line with the idea that anticipations of future income affect consumption materially.

Answer to Problem 1QAP

False

Explanation of Solution

The statement could be considered as false. According to natural experiment, it has been found out that current consumption is much reliant on the expectations of future income. For example, it has been disclosed that many retired individuals in households have enough savings invested in a sound manner to be used over the rest of their lifetime. This mean that they have saved them accordingly to be smoothed across a number of years into the future and depending on the amount, current consumption would be decided.

Economics Concept Introduction

Introduction:As per natural experiments, anticipations on future income greatly affect the consumption patterns of people. In other words, what individuals or households consume today is heavily reliant on what they expect they would receive as an income in future.

c)

To determine

The validity of the statement that anticipated growth of future income decline as a result of a financial crisis.

Answer to Problem 1QAP

True

Explanation of Solution

The statement could be considered as true. During a financial crisis, the financial sector of an economy collapses although not fully. At such times, many financial and economic variables start indicating negative or adverse performance levels. As the economy is not performing well the growth rate of future income cannot be expected to be high as before.

Economics Concept Introduction

Introduction:A financial crisis is an adverse situation where the financial sector of an economy would be hit by various events that are beyond control in most cases. At such a time, many economic variables start performing adversely. There are some variables whose behavior is in fact an indication of an upcoming financial crisis.

d)

To determine

The validity of the statement that the depreciation speed of buildings and factories are much faster than that of machines.

Answer to Problem 1QAP

False

Explanation of Solution

The statement could be considered as false. Buildings and factories take a much longer time to depreciate than machines. In fact, the depreciation of buildings and factories rely on the depreciation rate of machines. For example, assume that a building that can occupy 10 machines would depreciate in 10 years. Each machine would depreciate in one year. Machines will be used only one at a time. As such, when the first machine is fully worn out, the second will be brought to use. In that case a particular machine would have a lifetime of one year. Nevertheless, the building will be of good condition until the end of ten years.

Economics Concept Introduction

Introduction:Depreciation is the process where assets of a business would wear out as a result of usage and/or time. Provisions would be made in the accounting process of a business for depreciation. Such amounts would be deducted from the value of the asset on an annual basis.

e)

To determine

The validity of the statement that a high Tobin’s qis an indication of the stock market’s belief that capital value is being overvalued.

Answer to Problem 1QAP

False

Explanation of Solution

The statement could be considered as false. A high value obtained for Tobin’s q would suggest that capital’s value in relation to the current price is too low in reality. In other words, a higher Tobin’s q value is in fact a higher capital value relative to the purchase price at present. This simply means that investments must be higher.

Economics Concept Introduction

Introduction:Tobin’s q is a model that presents the ratio among an asset’s physical market value and its value of replacement. It was initially introduced in the 1960’s in an article called “Marginal productivity and macro-economic theories of distribution”.

f)

To determine

The validity of the statement that current profits would not affect investments unless it affects future profit expectations.

Answer to Problem 1QAP

False

Explanation of Solution

The statement could be considered as false. The relationship between current profit and investment could be used in explaining the impact on the latter from the former. However, investment is affected by both current expected future rates of real interest. If the current and expected interest rates are high, then the investment level would be low.

Economics Concept Introduction

Introduction:The impact of current profits and expectations on future profits could be considered as much connected to investments made. Current profit is the profit earned at the present point in time. Expected profit is the anticipated amount that would be received at a future point in time.

g)

To determine

The validity of the statement that business cycles and corporate profits are closely linked with emphasis on past data.

Answer to Problem 1QAP

True

Explanation of Solution

The statement could be considered as true. When the economic data of the US pertaining to the past three decades are being observed, it is clearly evident that business cycles create a great impact on corporate profits. At times of expansions, the profit values have been high. By contrary, at times of recession, profit values have been low.

Economics Concept Introduction

Introduction:A business cycle is the various stages a business or an economy at large has to go through. It has a number of stages that could be favorable as well as adverse. According to the specific characteristics of each stage, the overall performance of the firm would be affected.

h)

To determine

The validity of the statement that investment and consumption changes occur in the same direction and at similar magnitudes.

Answer to Problem 1QAP

False

Explanation of Solution

The statement could be considered as false. It is true that both investment and consumption change towards the same direction in response to various economic occurrences. However, the magnitude of the two are not the same. They are in fact much different. Ideally, relative movements in relation to consumption are much smaller than that of investments.

Economics Concept Introduction

Introduction:Consumption and investments are two economic aspects that are of great importance at both macro and micro levels. The two concepts usually go hand in hand. However, it is important to study if the magnitude of the two are same or not.