Deck 15: Investment spending

Question 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 1

increase investment spending to increase the capital stock

Question 2

Which of the following statements is FALSE?

A)investment is the primary link through which monetary policy affects the economy
B)faster growing countries often devote a larger share of GDP to investment
C)inventory and residential investment are relatively volatile but business fixed investment tends to be a fairly constant fraction of GDP
D)financial investment (buying stocks)is not part of real investment
E)the swings in investment are proportionally greater than the swings in total output

Answer 2

inventory and residential investment are relatively volatile but business fixed investment tends to be a fairly constant fraction of GDP

Question 3

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 3

the real interest rate plus the rate of depreciation

Question 4

Assume a Cobb-Douglas production function in which the share of capital is a = 0.25 and the share of labor is b = 0.75.If the rental cost of capital is rc = 10%, the desired capital stock of a cost-minimizing firm should be equal to

A)K* = 0.25Y
B)K* = 0.75Y
C)K* = 2.5Y
D)K* = 3.0Y
E)K* = 7.5Y

Question 5

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

Question 6

Which of the following is NOT included as investment in the national income accounts?

A)investment in human capital
B)investment in new knowledge
C)government investment in a country's infrastructure
D)financial investment (the buying of stocks and bonds)
E)all of the above

Question 7

The rental cost of capital will fall if

A)the expected rate of inflation decreases
B)the rate of depreciation increases
C)nominal interest rates increase more than the expected rate of inflation
D)all of the above
E)none of the above

Question 8

Which policy mix serves best to encourage an increase in business fixed investment?

A)high government spending and low corporate income taxes
B)high government spending and restrictive monetary policy
C)high government spending and removal of investment tax credits
D)low government spending and expansionary monetary policy
E)income tax cuts and restrictive monetary policy

Question 9

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%

Question 10

The theory of investment contains aspects of dynamic behavior since

A)the desired capital stock depends on a firm's estimate of current but not future output
B)firms generally close only a portion of the gap between their actual and desired capital stock in each period
C)there is always an immediate response to changes in the variables that affect the desired capital stock
D)rapid adjustments of the capital stock are cheaper and tend to interfere less with regular production than slow adjustments
E)none of the above

Question 11

Assume a Cobb-Douglas production function in which the share of capital is a = 1/4 and the share of labor is b = 3/4.In this case, the marginal product of capital is

A)Y/3K
B)3Y/4K
C)Y/4K
D)3Y/K
E)1/4

Question 12

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

Question 13

Assume the rental cost of capital is rc = 10%, the nominal interest rate is i = 13%, and the rate of depreciation is d = 4%.What is the real interest rate?

A)+9%
B)+6%
C)+3%
D)+1%
E)-1%

Question 14

Which of the following is FALSE?

A)in the long run, investment is one of the most important determinants of aggregate supply
B)aggregate supply depends on net investment
C)gross investment is a volatile part of aggregate demand
D)investment in human capital is not part of aggregate demand
E)the flow of investment is fairly small compared to the existing capital stock

Question 15

The increase in real output produced by using one additional unit of capital in production is called

A)the rental cost of capital
B)the marginal product of capital
C)the value of capital
D)capital improvement
E)capital consumption allowances

Question 16

Which of the following will decrease the rental cost of capital?

A)an increase in the nominal interest rate
B)an increase in the real interest rate
C)an increase in the rate of depreciation
D)an increase in the expected rate of inflation
E)a decrease in the expected rate of inflation

Question 17

It is important to understand the factors that influence investment spending since

A)investment is important in determining a nation's capital stock
B)investment behavior is of particular interest in the study of economic cycles
C)a nation's productive capacity is dependent on how much investment takes place
D)fiscal and monetary policies both significantly affect investment but often with a lag
E)all of the above

Question 18

According to the neoclassical theory of business fixed investment, which of the following is true?

A)investment spending is governed by the discrepancy between desired and actual interest rates
B)the desired capital stock decreases with a decrease in the rental cost of capital
C)monetary and fiscal policy changes affect investment spending but often with long lags
D)the desired capital stock decreases with an increase in the expected level of output
E)none of the above

Question 19

In the 1930s, investment as a share of GDP was very low because

A)businesses had very low sales expectations
B)the nominal interest rate was very high
C)the real interest rate was close to zero
D)expansionary fiscal policy resulted in huge budget deficits, crowding out investment
E)expansionary monetary policy resulted in high inflation creating uncertainty

Question 20

Investment spending

A)is responsible for much of the fluctuations in GDP
B) is greatly affected by interest rates and is thus the primary link through which monetary policy affects the economy
C) has little effect on aggregate supply in the short run
D)adds to the size of the capital stock and therefore helps to determine economic progress
E)all of the above

Question 21

A computer dealer who expects to sell 50 computers a month normally orders 50 new computers in the middle of each month to restock inventory for the next month.Now sales have fallen to 40 per month for two months in a row (Months 1 and 2), and the dealer decides to reduce inventory to 40 computers.How many computers will the dealer order in the middle of Month 3?

A)40
B)30
C)20
D)10
E)0

Question 22

At which times is credit rationing by banks likely to intensify?

A)in periods of rapidly falling interest rates
B)when the economy starts to enter a recession
C)when stock market values are rapidly increasing
D)when the central bank announces a change in monetary policy
E)none of the above

Question 23

If we compare the effects on aggregate demand of a temporary investment tax credit for firms and a temporary income tax cut for households, we realize that

A)a temporary income tax cut is more effective since consumption is a larger portion of aggregate demand than investment
B)neither one will change aggregate demand significantly since in both cases permanent rather than current income is important
C)both will change aggregate demand significantly since individuals as well as firms want to take advantage of lower taxes while they can
D)the personal income tax cut will increase aggregate demand while the higher tax credit will lower aggregate demand
E)temporary investment tax credits will help to simulate aggregate demand but temporary income tax cuts most likely will not

Question 24

If the government were to give investment tax credits in recessions and take them away again in booms, then the economy would

A)operate at a permanently higher level of output
B)never experience any business cycles
C)be less stable since businesses would hold back on investments early in recessions in anticipation of higher tax credits later
D)always operate at less than capacity
E)be more stable since long policy lags would no longer exist

Question 25

A booming stock market is good for capital investment since

A)whenever stock market values go up the economy is sure to follow
B)an increase in wealth will increase investment spending
C)firms have an easier time selling equity to raise funds for new ventures
D)buying stocks is an important part of investment spending
E)all of the above

Question 26

Which of the following statements accurately compares the three components of investment spending?

A)inventory investment is much smaller than the other two
B)residential investment is less interest sensitive than the other two
C)business fixed investment is more volatile than the other two
D)inventory investment is less volatile than the other two
E)none of the above

Question 27

If Tobin's q is greater than 1, then a firm should

A)lower its desired capital stock
B)issue more stocks to finance new capital investment
C)pay out more dividends to stockholders
D)borrow more funds from banks to finance new capital investment
E)lower its level of investment spending

Question 28

In the q-theory of investment, the q stands for

A)the level of investment divided by the level of GDP
B)the replacement cost of capital divided by the market value of a firm
C)the market value of a firm divided by the replacement cost of capital
D)the quantity of stocks outstanding divided by total earnings
E)the price-earnings ratio

Question 29

Which policy measure can help to increase the desired capital stock?

A)higher investment tax credits
B)a higher corporate income tax
C)restrictive monetary policy
D)an expansionary fiscal/restrictive monetary policy mix
E)none of the above

Question 30

The imposition of a temporary tax credit for just one year will

A)increase investment spending that year as firms take advantage of the tax credit
B)decrease investment spending the next year since firms will have accelerated investments originally planned for the next year
C)not significantly affect the level of capital stock in the long run
D)induce firms to undertake marginal investment projects that otherwise would not have been deemed profitable
E)all of the above

Question 31

According to the accelerator model,

A)the level of investment spending is proportional to the level of GDP
B)the change in investment spending is proportional to the change in GDP
C)the change in investment spending is proportional to the level of GDP
D)the level of investment spending is proportional to the change in GDP
E)none of the above

Question 32

If all changes in inventories were intended,

A)there would be no business cycle
B)the business cycle would be less extreme
C)the business cycle would be more extreme
D)there would be no relation between the business cycle and inventory investment
E)sales expectations would no longer influence inventory investment

Question 33

From the accelerator model we learn that

A)the level of investment is proportional to the level of output
B)the change in investment is proportional to the change in output
C)the change in investment increases as the level of output increases
D)the level of investment increases as the change in output increases
E)net investment decreases if the desired capital stock is greater than the actual capital stock

Question 34

The component of real investment that experiences the highest level of fluctuation is

A)business fixed investment
B)residential investment
C)inventory investment
D)public investment
E)financial investment

Question 35

The accelerator model states that if income growth slows down, net investment will

A)decline
B)increase but at a decreasing rate
C)be zero since only replacement investment will take place
D)be equal to the level of gross investment
E)be negative

Question 36

The q-theory of investment states that firms should add physical capital whenever

A)the value of q is greater than 1
B)the value of q is less than 1
C)the value of q is lower than the market interest rate
D)the replacement cost of capital is equal to the rental cost of capital
E)the market value of the firm divided by the replacement cost of capital is less than 1

Question 37

Which of the following is the most important source of financing investments for U.S.firms?

A)the bond market
B)the stock market
C)retained earnings
D)short-term bank debt
E)long-term bank debt

Question 38

Credit rationing implies that

A)some firms cannot borrow even though they are willing to do so at high interest rates
B)investment spending is affected not only by interest rates but also by the volume of profits and retained earnings
C)the central bank can affect the economy not just by changing interest rates but also by imposing credit controls
D)restrictive monetary policy by a central bank is reinforced by commercial banks' reluctance to extend loans for risky ventures
E)all of the above

Question 39

The notion of permanent output is important for investment since

A)the demand for capital depends on a normal or permanent level of output
B)firms always try to keep their level of investment spending fairly constant
C)firms expect current output to always be equal to permanent output
D)the difference between permanent output and current output is equal to inventory accumulation
E)current consumption depends on permanent income, and more consumption always leads to more investment

Question 40

According to the accelerator model, as GDP declines and the economy enters a recession, we should expect the level of net investment to

A)increase at a decreasing rate
B)decrease but remain positive
C)become zero
D)become negative
E)increase due to undesired inventories

Question 41

Residential investment is affected by monetary policy since

A)changes in the real interest rate affect the rate of return on residential investment
B)changes in the nominal interest rate affect the ability of many potential homebuyers to pay for a home or meet monthly mortgage payments
C)tighter monetary policy may induce mortgage lenders to ration credit
D)changes in interest rates may affect the ability of housing developers to get financing
E)all of the above

Question 42

If the market interest rate rises from 8% to 10%, the net present discounted value of a ten-year investment project will

A)fall more than a two-year project
B)rise more than a two-year project
C)fall less than a two-year project
D)rise less than a two-year project
E)not be significantly affected

Question 43

Many businesses hold inventories since

A)inventories are needed to meet future demand
B)it is often less costly to order materials in large quantities
C)inventories are often an unavoidable part of the production process
D)firms want to be able to smoothen out their production process
E)all of the above

Question 44

What is the approximate monthly payment for a 30-year fixed rate mortgage for a home valued at $100,000, if the mortgage interest rate is 8 percent?

A)$460
B)$550
C)$770
D)$890
E)$1,260

Question 45

Assume an investment promises to yield $4,400 after the first year, $4,840 after the second year, and $3,993 after the third year.If the market interest rate is i = 10% and is not expected to change over the next three years, what is the present discounted value of this investment?

A)$13,200
B)$12,900
C)$12,030
D)$11,200
E)$11,000

Question 46

In 2011, which of the following countries had the HIGHEST ratio of investment to GDP?

A)Canada
B)China
C)Japan
D)Singapore
E)United States

Question 47

If more and more firms adopt just-in-time manufacturing techniques, then we should see

A)more fluctuations in the inventory-to-sales ratio
B)a decline in the inventory-to-sales ratio
C)an increase in the rental cost of capital
D)many more unanticipated inventory changes
E)more economic fluctuations

Question 48

In 2011, the ratio of gross investment to GDP in the U.S.was

A)higher than that of China
B)roughly the same as that of China
C)roughly the same as that of Canada
D)higher than that of Canada
E)lower than that of Canada

Question 49

Which of the following happened in the U.S.in 2008?

A)businesses decreased their inventories but final sales dropped even faster
B)final sales dropped but business inventories dropped even faster
C)the ratio of business inventories to final sales dropped sharply
D)businesses increased their inventories before lending dried up
E)none of the above

Question 50

What is the approximate net present value of a machine that will save you $13,310 in each of the next three years, if the real interest rate stays at i = 10% during that period?

A)$39,930
B)$36,300
C)$33,100
D)$30,000
E)$26,620