Deck 18: Open-Economy Macroeconomics: Basic Concepts

Question 1

A firm renting out capital does not bear as cost the:

A)lost interest it could have earned by depositing the purchase price of the capital in a bank.
B)wear and tear on the capital.
C)wages of the labor that works with the capital.
D)capital loss or gain in the asset's value.

Answer 1

C

Question 2

The rate of depreciation is the:

A)nominal interest rate times the purchase price of capital.
B)capital losses resulting from decreases in the price of capital.
C)fraction of the value of capital lost per period because of wear and tear.
D)change in the q value of the firm.

Answer 2

C

Question 3

According to the neoclassical model of investment, business fixed investment does not depend on:

A)the realized profits of firms.
B)the marginal product of capital.
C)the interest rate.
D)tax rules affecting firms.

Answer 3

A

Question 4

The profit rate of a firm that rents capital is equal to:

A)the marginal product of capital minus the cost of capital.
B)the cost of capital minus the marginal product of capital.
C)zero.
D)a negative number, if it is adding to its capital stock.

Question 5

The real cost of capital is the:

A)purchase price of a unit of capital divided by the price level.
B)purchase price of a unit of capital minus the rate of inflation.
C)cost of a unit of capital less the marginal product of capital.
D)cost of buying and renting out a unit of capital measured in units of the economy's output.

Question 6

The neoclassical model of investment says investment depends negatively on the real interest rate because an increase in the real interest rate:

A)raises the cost of capital.
B)lowers the marginal product of capital.
C)lowers the real rental price of capital.
D)slows down the speed at which net investment responds to the incentive to invest.

Question 7

Business fixed investment includes:

A)rental housing that landlords buy to rent out.
B)goods businesses put aside in fixed storage facilities, including materials and supplies.
C)the fixed cost of borrowing that businesses pay for new equipment.
D)equipment and structures that businesses buy to use in production.

Question 8

The construction a new shopping center is an example of:

A)business fixed investment.
B)residential investment.
C)inventory.investment.
D)financial investment.

Question 9

The standard model of business fixed investment is called the of investment.

A)new classical model
B)neoclassical model
C)classical model
D)Keynesian model

Question 10

Other things being equal, the neoclassical model of investment predicts that net investment will increase when the:

A)marginal product of capital falls.
B)price of new capital goods rises.
C)real interest rate falls.
D)depreciation rate rises.

Question 11

The corporate income tax is a tax on the:

A)earnings of employees of a corporation.
B)dividends paid to the shareholders of a corporation.
C)earnings of the managers of a corporation.
D)profits of a corporation.

Question 12

The investment spending component of GDP includes all of the following except:

A)business fixed investment.
B)net foreign investment.
C)residential investment.
D)inventory investment.

Question 13

The most volatile component of real GDP is:

A)consumption spending.
B)government spending.
C)investment spending.
D)net exports.

Question 14

A capital rental firm makes a profit if the is the cost of capital.

A)real rental price of capital; less than
B)equilibrium marginal product of capital; less than
C)equilibrium marginal product of capital; equal to
D)equilibrium marginal product of capital; greater than

Question 15

If the capital stock is fixed and something happens to raise the marginal product of capital (MPK) for any given quantity of capital, then the real rental price of capital will:

A)remain the same.
B)rise.
C)fall.
D)fall and then rise.

Question 16

In equilibrium, other things being equal, all of the following changes will increase the real rental price of capital except:

A)a lower quantity of labor employed.
B)a lower stock of capital.
C)better technology.
D)a higher labor-capital ratio.

Question 17

According to the neoclassical model of investment, when the real interest rate increases, business fixed investment
Because the of capital increases.

A)increases; marginal product
B)increases; cost
C)decreases; marginal product
D)decreases; cost

Question 18

If the real rental price of capital is $10,000 per unit and the real cost of capital is $9,000 per unit, to maximize profits a firm should:

A)add to its capital stock.
B)let its capital stock shrink.
C)keep its capital stock unchanged.
D)reduce the real rental price of capital.

Question 19

If a great wave of immigration increased employment in the United States, this wave would:

A)increase the marginal productivity of capital in the United States.
B)decrease the marginal productivity of capital in the United States.
C)leave the marginal productivity of capital in the United States unchanged.
D)increase the marginal productivity of capital in the country from which the immigrants came.

Question 20

Investment spending is:

A)generally countercyclical.
B)generally procyclical.
C)unrelated to the business cycle.
D)generally procyclical for some components and generally countercyclical for others.

Question 21

According to Keynes, movements in stock prices:

A)follow a random walk.
B)reflect rational valuations of underlying economic fundamentals.
C)result when new information becomes available.
D)are often driven by irrational waves of optimism and pessimism.

Question 22

If stock prices follow a random walk, then:

A)changes in stock prices cannot be predicted from available information.
B)managed mutual funds should outperform index funds.
C)it would be easy to beat the market by buying undervalued stocks and selling overvalued stocks.
D)stock prices fluctuate for no good reason.

Question 23

If corporate profit were defined as the real price of capital minus the properly defined cost of capital, then:

A)having a tax on corporate profits would be more favorable to investment than having no tax at all.
B)having a tax on corporate profits would be less favorable to investment than having no tax at all.
C)having a tax on corporate profits would leave investment incentives the same as having no tax at all.
D)whether a corporate profits tax was more or less favorable for investment than no tax at all would depend on the rate of tax.

Question 24

For a firm facing financing constraints on its investment spending, the most important determinant of how much it invests is the:

A)firm's expected future profitability.
B)firm's current profitability.
C)interest rate.
D)firm's cost of capital.

Question 25

Other things being equal, the ratio of Tobin's q will rise if:

A)stock prices fall.
B)the replacement cost of capital rises.
C)more capital is installed.
D)stock prices rise.

Question 26

According to the efficient-market hypothesis, stock price changes reflect , but according to Keynes, stock price changes often reflect .

A)the inventory accelerator; changes in Tobin's q
B)changes in the real cost of capital; financing constraints
C)changes in the underlying economic fundamentals; irrational waves of optimism or pessimism
D)reductions in investment tax credits; the use of historical cost rather than replacement cost in computing depreciation costs

Question 27

The theory behind Tobin's q indicates that:

A)the stock market may be expected to predict every turning point in real GDP.
B)the stock market may be expected to be closely tied to fluctuations in output and employment.
C)every time investment goes up we would expect the stock market to go down.
D)the stock market and the economy are basically independent of each other.

Question 28

If Tobin's q is greater than 1, then managers should:

A)increase the capital stock of the firm.
B)maintain the existing capital stock of the firm.
C)allow inventories to run down.
D)decrease the capital stock of the firm.

Question 29

According to the efficient-market hypothesis, changes in stock prices are:

A)driven by irrational waves of optimism.
B)driven by irrational waves of pessimism.
C)rational reflections of underlying economic fundamentals.
D)possible to predict from available information.

Question 30

The existence of financing constraints makes investment:

A)more sensitive to current conditions.
B)less sensitive to current conditions.
C)spending follow a random walk.
D)spending increase during recessions.

Question 31

If the replacement cost of installed capital equals $20 trillion and the market value of installed capital equals $25 trillion, then according to q theory, businesses should:

A)add to capital stock.
B)let capital stock shrink.
C)keep capital stock unchanged.
D)reduce product prices to increase profits.

Question 32

According to the efficient-market hypothesis, changes in stock prices:

A)follow a random walk.
B)can be predicted from available information.
C)are driven by irrational waves of optimism and pessimism.
D)are based on what investors expect other investors to pay.

Question 33

Because of the way that U.S. tax law defines depreciation, depreciation for tax purposes is:

A)always less than true economic depreciation.
B)always greater than true economic
C)depreciation. always equal to true economic depreciation.
D)sometimes greater than true economic depreciation and sometimes less.

Question 34

During a credit crunch, financing constraints become prevalent and investment spending .

A)more; increases
B)more; decreases
C)less; increases
D)less; decreases

Question 35

If firms are earning a profit, then this raises the value of installed capital and implies a value of Tobin's
Q)

A)market; low
B)market; high
C)replacement; low
D)replacement; high

Question 36

The investment tax credit:

A)enables a firm to deduct a certain proportion of each dollar spent on capital goods from its profits.
B)enables a firm to deduct a certain proportion of each dollar spent on capital goods from its tax bill.
C)reduces the corporate tax rate in proportion to each dollar spent on capital goods.
D)allows a firm to count a certain proportion of each dollar spent on capital goods as depreciation expense.

Question 37

Because corporate income tax laws do not define profit to be the same as economic profit, many economists believe that the corporate income tax investment.

A)encourages
B)discourages
C)does not affect
D)promotes excessive

Question 38

is a share of ownership in a corporation, and the market is the market where these shares are traded.

A)Capital; capital
B)A dividend; stock
C)A bond; capital
D)Stock; stock

Question 39

Tobin's q equals the:

A)cost of buying and renting out one unit of capital measured in units of the economy's output.
B)marginal product of capital minus the cost of capital.
C)ratio of the replacement value of installed capital to the market value of installed capital.
D)ratio of the market value of installed capital to the replacement cost of installed capital.

Question 40

James Tobin reasoned that:

A)the stock market is a "random walk."
B)if the stock market values capital at less than its replacement cost, the stock market will go up.
C)if the stock market values capital at less than its replacement cost, the stock market will go down.
D)if the stock market values capital at less than its replacement cost, the firm's managers will not replace capital as it wears out.

Question 41

The price of housing relative to the price of other goods is determined in the short run by the:

A)cost of construction.
B)demand for the services of homes.
C)supply of existing homes.
D)supply and demand for the existing stock of homes.

Question 42

A toy manufacturer accumulates inventories because of the uncertainty of the demand for their product at Christmas and the desire not to lose any potential sales. This is an example of the motive for holding inventories.

A)production smoothing
B)inventories as a factor of production
C)stock-out avoidance
D)work in progress

Question 43

The stock-out avoidance motive for holding inventories suggests that:

A)firms hold inventories in order to produce more output.
B)when sales are low, firms produce more than they sell and put the extra goods in inventories.
C)firms hold inventories to avoid losing sales.
D)when a product is only partly completed, its components are counted as part of the firm's inventory.

Question 44

Holding other factors constant, an increase in population due to a large increase in immigrants will the price of housing and the flow of residential housing investment.

A)increase; increase
D)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 45

The inventories of a company that manufactures snow blowers increase in the summer and decline in the winter. This example is most consistent with which of the following explanations for holding inventories?

A)production smoothing
B)inventories as factors of production
C)stock-out avoidance
D)work in progress

Question 46

In the mortgage market, a rise in the real interest rate:

A)lowers housing demand, housing prices, and residential investment.
B)raises housing demand, housing prices, and residential investment.
C)lowers housing demand and residential investment but raises housing prices.
D)raises housing demand but lowers housing prices and residential investment.

Question 47

The construction of a new apartment building is an example of:

A)business fixed investment.
B)residential investment.
C)inventory investment.
D)financial investment.

Question 48

Residential investment equals the:

A)stock of existing housing.
B)flow of new housing.
C)demand for housing.
D)imputed rent from housing.

Question 49

Holding other factors constant, a decline in the real interest rate will the price of housing and the flow of residential housing investment.

A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 50

Inventory investment includes spending on:

A)equipment and structures that businesses buy to use in production.
B)goods that businesses put aside in storage, including materials and supplies, work in progress, and finished goods.
C)goods that businesses produce to sell to other businesses.
D)capital equipment less depreciation expense.

Question 51

Holding other factors constant, the decline in aggregate income during a recession will the price of housing and the flow of residential housing investment.

A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 52

The production-smoothing motive for holding inventories suggests that:

A)firms hold inventories in order to produce more output.
B)when sales are low, firms produce more than they sell and put the extra goods in inventories.
C)firms hold inventories to avoid losing sales.
D)when a product is only partly completed, its components are counted as part of the firm's inventory.

Question 53

In a typical recession, more than half the fall in spending comes from a decline in:

A)consumption spending.
B)business fixed investment.
C)government spending.
D)inventory investment.

Question 54

Inventory investment is the component of aggregate spending and very .

A)largest; volatile
B)largest; stable
C)smallest; volatile
D)smallest; stable

Question 55

The demand for housing is brought into equilibrium with the existing stock of housing by changes in the:

A)real interest rate. nominal
B)interest rate. relative
C)price of housing. overall
D)price level.

Question 56

Residential investment spending includes spending on:

A)new housing that people buy to live in and that landlords buy to rent out.
B)new and existing housing.
C)all houses purchased less the value of mortgages used to finance the houses.
D)only those houses that landlords buy to rent out.

Question 57

The inventories as a factor of production motive for holding inventories suggests that:

A)firms hold inventories in order to produce more output.
B)when sales are low, firms produce more than they sell and put the extra goods in inventories.
C)firms hold inventories to avoid losing sales.
D)when a product is only partly completed, its components are counted as part of the firm's inventory.

Question 58

During a banking crisis and credit crunch, the curve shifts leftward, resulting in a(n) in aggregate demand, production, and employment.

A)IS; increase
B)IS; decrease
C)LM; increase
D)LM; decrease

Question 59

In the long run, credit crunches:

A)have no lasting economic effects.
B)are offset by periods of credit ease.
C)improve the allocation of national saving, improving potential output.
D)misallocate national saving, reducing potential output.

Question 60

Loans made to subprime borrowers in the early 2000s had the immediate impact of housing demand and
Housing prices.

A)increasing; increasing
B)increasing; decreasing
C)decreasing; decreasing
D)decreasing; increasing

Question 61

Assume that the production function for an economy is given by Y = AKaHbL1 - a - b, where H is the stock of inventories. Then the marginal product of inventories (MPH) is given by MPH = bAKaL1 - a - bHb - 1. If the stock of inventories does not depreciate, the price of inventories is the same as the price of output, and taxes are ignored, then the real "cost of capital" for inventories is just the interest rate r.
a. Derive an expression for the "desired equilibrium stock of inventories" (H*) as a function of r and output Y by equating the cost of capital to MPH. (Hint: First substitute the production function into the expression for MPH to get MPH = bY/H.) If r = 0.1, b = 0.05, and Y = 5,000, what is the desired stock of inventories?
b. If r rose to 0.12, how would the desired stock of inventories change?

Question 62

If real interest rates increase, what will happen to:
a. business fixed investment?
b. residential investment?
c. inventory investment?

Question 63

Adding to the stock of spare parts that a manufacturer keeps on hand to replace worn out or broken parts is an example of:

A)the efficient markets hypothesis.
B)precautionary saving.
C)inventory investment.
D)reserve requirements.

Question 64

Suppose it is an election year and the economy is in a recession. The opposition candidate proposes an investment tax credit to take effect next year after he takes office. If the public believes the opposition candidate has a good chance of winning, the effect of this promise will likely be to:

A)increase investment both this year and next year.
B)decrease investment both this year and next year.
C)increase investment this year and decrease it next year.
D)decrease investment this year and increase it next year.

Question 65

Holding other factors constant, a fall in the interest rate will inventory investment.

A)increase
B)decrease
C)have no impact on
D)sometimes increase and sometimes decrease

Question 66

During recessions, investment spending usually decreases because:

A)the real interest rate falls.
B)lower profits mean more firms face financing constraints.
C)the purchase price of capital decreases.
D)corporate tax rates usually decrease.

Question 67

Business fixed investment, residential investment, and inventory investment as the real interest rate increases and as output increases.

A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 68

According to the neoclassical model of investment, the immediate impact of a rise in the real interest rate will be to:

A)increase the cost of capital, the rental price of capital, and the rate of investment.
B)increase the cost of capital and the rental price of capital, but to lower the rate of investment.
C)increase the rental price of capital and the rate of investment, but to leave the cost of capital unchanged.
D)increase the cost of capital and lower the rate of investment, but to leave the rental price of capital

Question 69

Inventory investment will decrease when interest rates and credit conditions are .

A)decrease; tight
B)decrease; easy
C)increase; easy
D)increase; tight

Question 70

Assume that the government levies a one-time-only tax on oil companies equal to a proportion of the value of the company's oil reserves. According to the neoclassical model, if firms face no financing constraints and also believe the tax will not be repeated, the effect of this tax on investment by these firms will be to:

A)decrease investment.
B)Not affect investment.
C)increase investment.
D)decrease the rental price of capital but not change the cost of capital.

Question 71

How will a decrease in output during a recession affect:
a. business fixed investment?
b. residential investment?
c. inventory investment?

Question 72

The investment demand function would shift for all of the following reasons except:

A)an improvement in technology raises the marginal product of capital.
B)an increase in population raises the demand for housing.
C)an increase in government spending raises the real interest rate.
D)the investment tax credit is reinstated.

Question 73

Economic booms should stimulate investment spending because during booms:

A)the real interest rate increases.
B)corporate tax rates usually increase.
C)the purchase price of capital increases.
D)higher levels of employment increase the marginal product of capital.

Question 74

Inventory investment, at least in theory, should:

A)rise when the real interest rate rises, other things being equal.
B)not depend on the real interest rate, other things being equal.
C)fall when the real interest rate rises, other things being equal.
D)depend only on the change in real GDP.

Question 75

According to Hall, consumption spending follows a random walk and, according to the efficient-markets model, stock prices follow a random walk.
a. What determines changes in consumption and stock prices in this case?
b. What is the implication of following a random walk for predicting changes in consumption and stock prices?

Question 76

The opportunity cost of holding inventories is the:

A)real interest rate.
B)nominal interest rate.
C)raw materials used up in the production of inventories.
D)labor used in the production of inventories.

Question 77

The real interest rate should be inversely related to investment in:

A)plant and equipment, home building, and inventories.
B)plant and equipment and home building, but not inventories.
C)plant and equipment and inventories, but not home building.
D)inventories and home building, but not plant and equipment.

Question 78

The work in process motive for holding inventories suggests that:

A)firms hold inventories in order to produce more output.
B)when sales are low, firms produce more than they sell and put the extra goods in inventories.
C)firms hold inventories to avoid losing sales.
D)when a product is only partly completed, its components are counted as part of the firm's inventory.

Question 79

According to the neoclassical model of investment, the immediate impact of an earthquake that destroys part of the capital stock will be to:

A)increase the cost of capital, the rental price of capital, and the rate of investment.
B)increase the rental price of capital and the rate of investment, but to leave the cost of capital unchanged.
C)increase the rental price of capital and the cost of capital, but to leave the rate of investment unchanged.
D)increase the rental price of capital and the rate of investment, but to decrease the cost of capital.

Question 80

As firms' profits increase during a boom, business fixed investment will increase because:

A)the marginal product of capital falls.
B)stock-out avoidance diminishes.
C)corporate tax payments decrease.
D)the high profit levels relax financing constraints.