Consumption smoothing is an implication of the neoclassical model of consumption

Question

Consumption smoothing is an implication of the neoclassical model of consumption. This is because a rise in income either today or in the future reduces present value consumption, smoothing consumption. The arbitrage condition for capital shows that returns to a bank account are equal to the user cost of capital. If the real interest rate is more or less constant and the growth rate of dividends falls sharply, the price-earnings ratio would fall, all else equal. According to the Congressional Budget Office report "A 125-Year Picture of the Federal Government's Share of the Economy, 1950 to 2075," the share of government spending in GDP will climb to 40 percent by 2075, assuming current federal government policies. According to the law of diminishing returns, the longer we live, the more we will be willing to pay relatively for medical care than for other goods and services.

Explanation / Answer

(a) The consumption smoothing is an implication of the neoclassical model of consumption. This is because a rise in income either today or in the future reduces present value consumption, smooth consumption. The statement is True.

(b) The statement is False. The arbitrage condition for capital shows that returns to a bank account are equal to the user cost of capital. The former is more than later in teh statement to be true.

(c) The statement is False. If the real interest rate is more or less constant and the growth rate of dividends falls sharply, the price earnings ratio would fall, all else equal. It would contrary, would show increase in the price earning ratio.

(d) The statement is True. According to the Congressional Budget office report "A 125 year picture of the federal government's share of economy, 1950 to 2075," the share of government spending in GDP will climb to 40 percent by 2075, assuming current federal government policies.

(e) The statement is True. According to the law of diminishing returns, the longer we live, the more we will be willing to pay relatively for medical care than for other goods and services.

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