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3 Investment Spending Answer

This document contains a tutorial on investment spending and capital stock. It includes 6 multiple choice questions about key concepts such as: 1) When a firm should increase investment spending; 2) When a firm will stop investing; 3) What factors influence the desired capital stock level. It also provides examples of calculating the rental cost of capital from interest rates and depreciation. To maintain the existing capital stock, investment must cover depreciation to replace worn or obsolete capital.

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13 views2 pages

3 Investment Spending Answer

This document contains a tutorial on investment spending and capital stock. It includes 6 multiple choice questions about key concepts such as: 1) When a firm should increase investment spending; 2) When a firm will stop investing; 3) What factors influence the desired capital stock level. It also provides examples of calculating the rental cost of capital from interest rates and depreciation. To maintain the existing capital stock, investment must cover depreciation to replace worn or obsolete capital.

Uploaded by

tookshirli
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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ECO 287 Macroeconomics II

Tutorial 3
Chapter 15 Investment Spending

1) If the marginal product of capital is above the rental cost of capital, then a firm should
A) increase investment spending to increase the capital stock
B) decrease investment spending since any new investment projects will be unprofitable
C) leave investment spending at the current level since any additions to the existing capital
stock will not be profitable
D) undertake only replacement investments since any additions to the capital stock will not
be profitable
E) lower the actual capital stock by not replacing machines that have broken down in the
production process

Answer: A

2) A firm will keep investing until the value of the marginal product of capital is equal to
A) the rental cost of capital
B) the value of the marginal product of labor
C) the rate of depreciation minus the real interest rate
D) the market interest rate minus the rate of depreciation
E) total output divided by the capital stock

Answer: A

3) In which of the following cases would you expect to observe the highest level of desired
capital stock?
A) the rental cost of capital is high and wage rates are low
B) the rental cost of capital is low and the level of output is high
C) the rental cost of capital is low and the level of output is low
D) the level of output is low and wage rates are high
E) the level of output is low and wage rates are low

Answer: B

4) Assume the nominal interest rate is i = 10%, the real interest rate is r = 7%, and the rate of
depreciation d = 6%. What is the rental cost of capital?
A) 16%
B) 13%
C) 9%
D) 4%
E) 1%

Answer: B

5) Leaving taxes aside, a firm will calculate its rental cost of capital as
A) the nominal interest rate
B) the real interest rate
C) the real interest rate plus the rate of depreciation
D) the real interest rate minus the rate of depreciation
E) the nominal interest rate minus the rate of depreciation

Answer: C

6) Assume the rental cost of capital (rc) = 10%, the nominal interest rate (i) = 13%, and the
rate of depreciation (d) = 4%. What is the real interest rate?
A) 9%
B) 6%
C) 3%
D) 1%
E) -1%

Answer: B rc=real interest rate + d


10=real interest rate +4
Real interest rate = 6

Application:
If an economy has achieved its desired capital stock and wishes merely to maintain it, should
any investment occur? If not, why not? If so, how much?

Even if the economy has achieved the desired capital stock, some gross investment must still take
place to keep the capital stock at this level. The level of investment has to be sufficient to cover
depreciation, that is, the amount of capital that has to be replaced due to wear and tear in the
production process or because equipment becomes obsolete.

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