Liquidity constraints explain
A)why consumers may spend less than the permanent-income theory predicts as their current income falls
B)why consumption may increase more than the life-cycle hypothesis predicts when income recovers after a recession
C)why consumers may sometimes behave in a manner predicted by the simple Keynesian consumption function
D)all of the above
E)none of the above

Question

Quizplus · Accepted Answer

Liquidity constraints refer to the situation where individuals are constrained by the availability of liquid assets to finance their consumption or investment decisions. When faced with liquidity constraints, consumers may reduce their spending even if their permanent income remains the same (option A). However, when income recovers after a recession, consumers may increase their spending more than what is predicted by the life-cycle hypothesis. This is because they may have deferred spending during the recession due to liquidity constraints (option B). The simple Keynesian consumption function also assumes that consumers have liquidity constraints, which is why consumers may behave in a manner predicted by this theory (option C). Therefore, all of the above options are correct.

Liquidity Constraints Explain