Deck 11: Investment Demand

Question 1

Suppose that an investment tax credit that would come on line in the next tax year were enacted to try to avoid an anticipated recession. The result of this type of delayed policy would be

A) a slowing of the downturn toward recession as investment rose in anticipation of the credit.
B) an acceleration of the downturn toward recession as investment initially fell in anticipation of putting off planned capital projects until they would be eligible for the tax credit.
C) an immediate increase in the interest rate that would cancel the stimulus and guarantee the recession.
D) no effect at all until the credit were applicable next year.
E) none of the above.

Answer 1

an acceleration of the downturn toward recession as investment initially fell in anticipation of putting off planned capital projects until they would be eligible for the tax credit.

Question 2

One reason advanced to explain why housing is a leading indicator is that

A) the demand for housing depends on real GDP and declines in real GDP always precede the onset of recession.
B) the demand for housing depends on the real interest rate and real interest rates generally climb as economies begin to turn down into recession.
C) the demand for housing depends at least indirectly on the prices of construction materials and those prices always accelerate during the inflationary booms that precede recessions.
D) the demand for housing depends critically on nominal GDP, which always falls during the inflation that precedes recession.
E) none of the above.

Answer 2

the demand for housing depends on the real interest rate and real interest rates generally climb as economies begin to turn down into recession.

Question 3

The rental price of housing is correlated

A) positively with both the real interest rate and the price of physical housing.
B) positively with the real interest rate and negatively with the price of physical housing.
C) negatively with both the real interest rate and the price of physical housing.
D) negatively with the real interest rate and positively with the price of physical housing.
E) only with the real rate of interest because supply and demand in the competitive building industry keep the price of housing extraordinarily stable.

Answer 3

positively with both the real interest rate and the price of physical housing.

Question 4

The view of Keynes that investment drives an economy and makes it vulnerable to the capricious effects of speculative expectations

A) accurately describes recent experience in the United States.
B) is a bit overstated in the light of investment's general correlation with real GDP and the forward-looking construction of business and consumption expectations.
C) might be correct, unless consumption expectations are out of sync with business expectations.
D) is not at all correct, given the relative stability of the investment component of aggregate demand.
E) is entirely false when one corrects for the effect of changes in the rental price of capital.

Question 5

Fixed investment in the United States

A) moves up and down with GDP but is less volatile than any measure of total output.
B) moves countercyclically with GDP in a pattern far more volatile than the other components of aggregate demand.
C) moves up and down with GDP but is more volatile than the other components of GDP.
D) appears to be independent of the level of GDP but is sufficiently volatile to explain more than 50 percent of the short-run variation in aggregate demand.
E) moves up and down with GDP but is the least volatile component of aggregate demand.

Question 6

Given a rental price for capital, the level of employment of capital

A) increases with the wage rate but decreases with output.
B) increases with both the wage rate and output.
C) decreases with the wage rate and increases with output.
D) decreases with both the wage rate and output.
E) moves either up or down with output depending on the size of income and substitution effects.

Question 7

Let the level of planned output decline during an economic downturn. To illustrate the effects of this decline, you would expect to see the marginal benefit schedule for capital

A) shift up and to the right.
B) shift up and to the left.
C) shift down and to the right.
D) shift down and to the left.
E) move along the demand curve for labor to a lower level of employment.

Question 8

Of the three major components of investment,

A) nonresidential fixed investment dominates, but inventory volatility gives it a primary role in driving the business cycle.
B) residential fixed investment dominates and therefore plays a primary role in driving the business cycle.
C) inventory holdings dominate, but the volatility of nonresidential fixed investment is a primary source of business cycle fluctuation in GDP.
D) only residential fixed investment depends on real GDP and therefore has anything to do with the business cycle.
E) none of the above.

Question 9

Investment is generally sensitive to changes in the real interest rate because

A) all three of the components of investment are sensitive to the interest rate.
B) nonresidential investment falls as the interest rate climbs because the higher rental price of capital inspires substitution into the relatively lessexpensive employment of labor.
C) residential investment falls as the interest rate climbs because the interest rate is a major component of the rental price of housing.
D) inventories fall as the interest rate climbs because the interest rate is a major component of the holding cost of inventories.
E) all of the above.

Question 10

Of the three major components of investment in the United States,

A) housing is a leading indicator of future changes in GDP, whereas business investment tends to move contemporaneously with output.
B) inventory behavior is a lagging indicator of changes in GDP, whereas housing tends to move contemporaneously with output.
C) inventory behavior tends to move contemporaneously with GDP, whereas business investment and housing serve as fundamental leading indicators of future changes in output.
D) only business investment is a leading indicator of future changes in GDP.
E) only inventories are volatile over the business cycle.

Question 11

For a firm choosing not to purchase its own stock of capital, total rental costs include which of the following?

A) The purchase price of the new piece of capital
B) The real interest rate
C) The rate of depreciation
D) All of the above
E) Only b and c

Question 12

Let the wage rate climb. The marginal benefit schedule for capital must therefore shifts

A) up and to the right.
B) up and to the left.
C) down and to the right.
D) down and to the left.
E) along a demand curve to reflect higher demand for capital.

Question 13

Inventories in the United States

A) moved up in 1974 and 1983 due to an unintended buildup of finished goods inventories.
B) moved down in 1974 because of an anticipated mild recession.
C) moved up in 1958 because of a correctly foreseen recovery in 1958.
D) moved down in 2001 by the largest amount since 1960.
E) a and d.

Question 14

The conclusion that the firm makes use of capital up to the point where the marginal benefit of capital equals the rental price of capital is

A) supported by the capital budgeting approach but not the rental approach.
B) supported by the rental approach but not the capital budgeting approach.
C) supported by neither the capital budgeting approach nor the rental approach.
D) supported by both the capital budgeting approach and the rental approach.
E) a direct result of a firm that owns its own stock of capital.

Question 15

Let the real rate of interest equal 5 percent, set the rate of depreciation equal to 10 percent, and normalize the price of a piece of capital at $10,000. In this case, the rental price of capital would equal

A) $500.
B) $1,000.
C) $1,500.
D) $10,000.
E) $666.67.

Question 16

For the purposes of integrating forward-looking business investment decisions into a model of macroeconomic behavior, capital employment decisions proceed along at least two dimensions. The most important of these considerations are

A) how much capital stock to maintain and how much to depreciate.
B) how much capital stock to maintain and how quickly to achieve that stock by a flow of investment expenditure.
C) how much capital to rent and how much to purchase.
D) how much of the capital that is rented should be depreciated and how much should be sent back.
E) how fast to expand the capital stock of a growing division and how fast to contract the capital stock of a failing division.

Question 17

In general, the rental price of capital is

A) decreased by the amount of an expected increase in the price of capital.
B) increased by the amount of an expected increase in the price of capital.
C) not affected by the amount of an expected increase in the price of capital.
D) determined only by the real interest rate, depreciation, and the actual price of capital.
E) rarely considered by most firms operating in the real world.

Question 18

Dale Jorgenson modeled the capital employment decision given a targeted output as one of how much capital to rent at a given rental price. One major implication of his approach is

A) that the capital employment decision is no different from the employment decision for any other input.
B) that capital be hired up until the point where its marginal benefit equals the rental price.
C) that the private marginal cost of employing capital can be viewed as the market clearing rental price of capital.
D) all of the above.
E) a and c only.

Question 19

The paradox of thrift is

A) a concern of macroeconomists of all persuasions.
B) a concern of the Keynesian economists that is enlarged if investment is positively correlated with GDP.
C) not a concern of the new classical economists because of their belief that price adjustments always maintain actual GDP at its potential.
D) really a fallacy of logic because higher saving produces higher investment, which produces greater aggregate demand and faster growth.
E) b and c.

Question 20

The marginal benefit schedule for capital slopes downward because

A) it is the demand curve for capital and all demand curves slope downward.
B) the marginal productivity of labor increases with the quantity of capital.
C) the level of output associated with any quantity of capital declines with the quantity of labor employed.
D) the marginal productivity of capital declines with the quantity of capital.
E) none of the above.

Question 21

Investment tends to increase with

A) the wage rate and GDP but fall with the rental price of capital.
B) GDP but fall with the rental price of capital and the wage rate.
C) GDP and the rental price of capital required to maintain supply but fall with the wage rate.
D) GDP, the wage rate, and the rental price of capital required to maintain supply.
E) none of the above.

Question 22

Let net investment based on the accelerator principle predict that net investment will equal twice the change in GDP in a given year. If GDP is expected to climb from $2 to $2.2 trillion with an initial capital stock of $3 trillion facing an annual rate of depreciation of 10 percent, then gross investment should be expected to be somewhere in the neighborhood of

A) $300 billion.
B) $400 billion.
C) $520 billion.
D) $620 billion.
E) $700 billion.

Question 23

Just as would be predicted by a forward-looking theory of investment, response to the Tax Reform Act of 1986 included

A) an increase in investment in business equipment in the first quarter of 1986 after a reduction of similar magnitude in the last quarter of 1985.
B) an increase in investment in business equipment appearing suddenly in January 1986.
C) a reduction in investment in business equipment in the first quarter of 1986 after an increase of similar magnitude in the last quarter of 1985.
D) a reduction in investment in business equipment appearing suddenly in January 1986.
E) almost no change in investment in business equipment either late in 1985 or early in 1986.

Question 24

Let the nominal rate of interest be 10 percent in the face of expected inflation equaling 6 percent. Suppose further that the price of capital is expected to climb from an index number of 100 at the same pace as the overall price index. Imposing a 20 percent tax on rental income and allowing a 20 percent credit against income tax liability for the purchase of new capital should

A) leave the rental price of capital fixed at 8 percent of the price of capital.
B) leave the rental price of capital fixed regardless of the rate of depreciation.
C) cause the rental price of capital to rise or fall depending on the rate of depreciation.
D) cause the rental price to fall if depreciation is low enough.
E) none of the above.

Question 25

Given a wage for labor and a planned level of output, an increase in the rental price of capital can be expected to

A) increase the employment of both labor and capital.
B) increase the employment of capital but reduce the employment of labor.
C) increase the employment of labor but reduce the employment of capital.
D) reduce the employment of both capital and labor.
E) cause adjustments in the employment of capital and labor of indeterminate direction.

Question 26

Suppose that an economy with a $4 trillion dollar GDP supported by a $6 trillion dollar capital stock were at the end of two years of no real growth. If people expected the no-growth circumstance to continue and faced depreciation of 5 percent per year, then the accelerator model of investment would predict

A) gross investment equal to $300 billion supporting net investment of $0.
B) gross investment equal to $200 billion supporting net investment of $0.
C) gross investment equal to $0 supporting net investment of $300 billion.
D) gross investment equal to $0 supporting net investment of $200 billion.
E) none of the above.

Question 27

In recent years in the United States,

A) net investment has run at levels far greater than the total depreciation gap between GDP and NDP.
B) net investment has run at levels remarkably close to the total depreciation gap between GDP and NDP.
C) net investment has run at levels far lower than the total depreciation gap between GDP and NDP.
D) net investment has run at levels that, when expressed as a fraction of GDP, exceed the investment activity of all of the world's developed economies with the exception of Japan.
E) c and d only.

Question 28

The ratio of the rental price of housing to the price of housing is lower than the ratio of the rental price of capital to the price of capital because

A) houses are so much more expensive than capital.
B) most housing built in the United States is far less expensive than the typical capital project.
C) housing depreciates at a much slower rate than physical capital.
D) the rate of inflation in the price of housing is far greater than the rate of inflation in the price of capital.
E) the price of capital is set in an imperfectly competitive market, whereas the price of housing is determined by the workings of a nearly competitive market.

Question 29

The income tax system of the United States can discourage investment. This tendency, however, can be offset by the stimulative effects of

A) increasing the tax credit percentage that firms can subtract from their tax liabilities.
B) allowing interest payments to be deducted from income before tax liability is computed.
C) allowing depreciation to be deducted more quickly from income before tax liability is computed.
D) lowering the real rate of interest through macroeconomic policy.
E) all of the above.

Question 30

Inventories in the United States

A) usually move up and down with nominal, but not real, GDP.
B) usually move up and down with the price component of nominal GDP.
C) usually move up and down with real GDP.
D) can occasionally climb or fall relative to real GDP if the macroeconomy is beset by some unexpected downturn or upswing.
E) c and d.

Question 31

There have been times during which changes in investment have not produced changes in GDP. For that to happen, as it did in 1986, a reduction in investment must be accompanied by which of the following?

A) An increase in consumption expenditure
B) An increase in government expenditure
C) An increase in net exports
D) A reduction in net imports
E) Any of the above

Question 32

In specifying the demand for housing in terms of the rental price of housing, it is implicitly assumed that the demand for housing varies

A) positively with both the real rate of interest and the price of housing.
B) positively with the real rate of interest and negatively with the price of housing.
C) positively with the price of housing and negatively with the real rate of interest.
D) negatively with both the real rate of interest and the price of housing.
E) positively with the real rate of interest and, more important, with GDP.

Question 33

Let the expected rate of inflation equal 10 percent and the corresponding nominal rate of interest be 15 percent. If the rate of depreciation were 10 percent and the price of a piece of capital $10,000, then an entrepreneur charging the appropriate rental price of capital

A) would earn an extra 2 percent in real return if actual inflation were 8 percent instead of 10%.
B) would earn the same 5 percent real return regardless of what actual inflation happened to be.
C) would earn 17 percent in real return if actual inflation were 8 percent instead of 10 percent.
D) would earn something less than 5 percent if actual inflation were 8 percent instead of the anticipated 10 percent.
E) none of the above.

Question 34

Excluding the inventory component, which of the following statements is accurate?

A) Gross investment must be nonnegative, but net investment must be negative if the desired level of capital is smaller than last year's capital stock.
B) Gross investment can be either positive or negative, but net investment must be negative as long as the desired level of capital is smaller than last year's capital stock.
C) Gross investment must be nonnegative, but net investment can be negative or positive if the desired level of capital is smaller than last year's capital stock.
D) Gross investment must be nonnegative because net investment must always be positive.
E) None of the above.

Question 35

Let the nominal rate of interest be 15 percent with expected inflation
Running 10 percent. With depreciation pegged at 10 percent and a fixed price of capital, a 50 percent tax on the revenue from capital

A) requires that the rental price of capital increase by 100 percent to maintain the quantity demanded.
B) requires that the rental price of capital increase by 50 percent to maintain the quantity demanded.
C) requires that the rental price of capital increase by 100 percent to maintain the supply of capital at existing quantities.
D) requires that the rental price of capital increase by 50 percent to maintain the supply of capital at existing quantities.
E) none of the above.

Question 36

Suppose that the desired capital stock is always equal to three times total output for any year. In that case, the accelerator principle implies that investment should always

A) equal some constant multiple greater than 3 times the annual change in GDP to accommodate depreciation.
B) be precisely equal to three times the annual change in GDP regardless of the rate of depreciation.
C) equal some constant multiple less than three times the annual change in GDP to accommodate depreciation.
D) be proportional to the annual change in GDP, but the information provided is insufficient to compute the multiple exactly.
E) none of the above.

Question 37

Both capital budgeting and rental approaches to capital employment decisions agree that

A) capital should be "hired" under imperfect competition as long as the marginal benefit of capital is climbing to its rental price.
B) capital should be "hired" under perfect competition as long as the marginal benefit of capital is climbing to its rental price.
C) capital should be "hired" as long as the marginal benefit of capital is climbing to its rental price regardless of market structure.
D) capital should be "laid off" as long as the marginal benefit of capital is falling to its rental price even under imperfect competition.
E) none of the above.

Question 38

Empirical evidence collected and analyzed for the United States economy suggests that

A) hardly any of a desired change in the capital stock can be accomplished in one year's time.
B) only certain types of a desired change in the capital stock can be accomplished in one year's time.
C) most of a desired change in the capital stock can be accomplished in one year's time.
D) almost all of a desired change in the capital stock can be accomplished in one year's time.
E) one year is sufficient time to complete all of any desired change in the capital stock.

Question 39

Given a lag structure in the investment patterns that bring the actual capital stock in line with the desired stock, a reduction in the price of capital should mean that

A) the marginal revenue earned by new capital projects should exceed the rental price of capital for a while.
B) both gross and net investment should be positive for a while.
C) the ratio of the market value of most firms to the price of their capital stock should exceed unity for a while.
D) all of the above.
E) none of the above.

Question 40

Which of the following provisions of the Tax Reform Act of 1986 worked to raise the effective cost of capital?

A) A general reduction in the tax rates applied to corporate profits
B) The elimination of the investment tax credit
C) A reduction in depreciation allowances
D) A reduction of the effective interest rate deduction against taxable corporate income

Question 41

Inventory holdings are fractionally composed of finished goods held in buffer stocks, on the one hand, and material inputs, on the other. The fractions, in the United States, have hovered recently around

A) half in finished goods and half in materials.
B) two-thirds in finished goods and one-third in buffer stocks.
C) two-thirds in finished goods and one-third in materials.
D) one-third in finished goods and two-thirds in materials.
E) no particular distribution because of the variability of the real interest rate.

Question 42

A capital gains tax rate reduction stimulates investment because

A) it is one of the determinants of the rental price of capital.
B) it determines in part shareholders' total tax liabilities from capital stock investment.
C) research has shown that a tax policy that lowers the rental price of capital by 1 percent raises investment by about 1 percent over several years.
D) all of the above.
E) none of the above.

Question 43

Housing demand is affected significantly by changes in monetary policy because

A) the rental price of housing is dominated by the real interest rate, the major vehicle through which monetary policy generates its short-run effectiveness.
B) the rental price of housing is dominated by the rate of inflation of consumer prices, the major target of monetary policy in the United States.
C) the price of housing is extremely sensitive to changes in the nominal rate of interest, the major vehicle through which monetary policy generates its short-run effectiveness.
D) of the long-run potency of monetary policy in influencing GDP.
E) none of the above.

Question 44

An investment tax credit, typically used to stimulate investment spending considered to be too low,

A) increases the cost of capital to firms through the addition of new taxes.
B) provides a taxpayer subsidy directly to firms making capital expenditures.
C) provides little incentive for a permanently higher level of capital stock.
D) should provide a burst of net investment activity in the economy, but little support has been found for this hypothesis.
E) has no effect on the volatility of investment, since investment is low when such a policy is warranted and consequently restored only to where it should have been.

Question 45

A major reason why inventories are so strongly correlated with GDP is that

A) the larger fraction of inventory holdings are in material inputs, which are bid down when GDP grows quickly and expand when GDP grows slowly.
B) the larger fraction of inventory holdings are in material inputs, which are bid up or down) in anticipation of strong or weak) growth in GDP and thereby cause a self-fulfilling stimulus or depressant).
C) their holdings are so strongly correlated with other, interest-insensitive forms of investment.
D) b and c.
E) none of the above.

Question 46

When the strong positive correlation between inventories and GDP is violated, it is usually because

A) forward-looking businesses missed a turn in aggregate demand and buffer stocks either climb as GDP falls or fall as GDP climbs.
B) forward-looking businesses missed a turn in aggregate demand and their pipeline holdings of material inputs are bid up as GDP falls or bid down as GDP rises.
C) investment projects undertaken by businesses cost more than expected during inflationary upturns.
D) investment projects lose significant amounts of money when they are undertaken during deflationary recessions.
E) none of the above.

Question 47

Suppose investment is independent of GDP. Which answer describes an IS-LM representation of a second economy in which investment is positively correlated with GDP?

A) No change in either the IS or the LM curves
B) A flatter IS curve and an unchanged LM curve
C) A steeper IS curve and an unchanged LM curve
D) A flatter LM curve and an unchanged IS curve
E) A steeper LM curve and an unchanged IS curve

Question 48

The dependence of investment on the level of GDP is based on

A) the fact that replacement investment is linked to the level of the capital stock and thus GDP.
B) the fact that finished goods inventory investment is closely related to the level of GDP.
C) the fact that unfinished goods inventory investment is closely related to the level of GDP.
D) the fact that investment in new housing is closely tied to the level of GDP.
E) none of the above.

Question 49

In 2002, United States inventories amounted to

A) almost 14 percent of GDP, about 1.6 months of annual production.
B) almost 40 percent of the manufacturing and trade component of GDP, about five months of annual production.
C) almost 40 percent of total annual depreciation expenses.
D) less than 10 percent of the size of the federal budget deficit and thus contributed little to the absorption of private saving.
E) none of the above.

Question 50

Which of the following reasons provides an additional stimulus for investment?

A) Higher output requires firms to invest in new plants and equipment.
B) Higher output causes families to increase their stock of housing.
C) Higher output calls for higher pipeline stocks of inventories.
D) All of the above.
E) Only a and b.

Question 51

Let investment be given by I = 500 - 1,200R + 0.4Y, C = 200 + 0.75YD, the personal income tax rate equal 33 percent, and 0.8Y - 2,400 = M/P. If government spending equals 500 and the nominal money supply equals 100, which of the following represents the corresponding aggregate demand curve?

A) Y = 2,000 - 0.833M/P.
B) Y = 2,000 - 0.667M/P.
C) Y = 0.833M/P - 2,000.
D) Y = 0.833M/P + 2,000.
E) Y = 0.667M/P - 2,000.

Question 52

For the economy as a whole, the volume of investment undertaken each year is a joint outcome of which of the following factors?

A) Decisions made by businesses about the amount of investment to undertake
B) Decisions made by consumers about the amount to save
C) Decisions made by producers of investment goods about how much to supply
D) All of the above
E) Only a and c