Question

1) According to the permanent income hypothesis, current consumption is a function of:
(a) current income, only;
(b) expected income over a three-year time horizon;
(c) wealth, including human capital;
(d) all of the above.

2) The consumer price index is an inadequate deflator for GDP because:
(a) it measures the prices of a representative market basket of consumer goods and services purchased by an urban household only;
(b) it is calculated only once a year (wrong bc CPI is calculated monthly, not yearly);
(c) the CPI has a distorted nondurable goods component;
(d) the personal consumption expenditures deflator covers the prices of all goods and services included in the GDP.

Answer 1

1). (d) all of the above.

The consumption function is an equation describing how a household’s level of consumption varies with its disposable income. In order to fully understand the consumption function, we need to understand a few ideas about household income and how they choose to use that income.

2). (c) the CPI has a distorted nondurable goods component.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.