Deck 17: The Theory of Investment

Question 1

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.

Answer 1

increase the marginal productivity of capital in the United States.

Question 2

If the price index for capital goods is the same as the price index for other goods, an index of the real cost of capital for investment, in the absence of taxes, may be summarized as the:

A) nominal interest rate plus the depreciation rate.
B) real interest rate plus the depreciation rate.
C) purchase price of a capital good multiplied by the sum of the nominal interest rate plus the depreciation rate.
D) purchase price of a capital good multiplied by the sum of the real interest rate plus the depreciation rate.

Answer 2

real interest rate plus the depreciation rate.

Question 3

Use the following to answer questions :
Exhibit: Rental Price of Capital
(Exhibit: Rental Price of Capital) Based on the graph, if the capital market is initially in equilibrium at A with real rental price R₃/P and capital stock K₂, then holding other factors constant, an increase in the quantity of labor employed will move the real rental price of capital to:

A) R₁/P.
B) R₂/P.
C) R₄/P.
D) R₅/P.

Answer 3

R₂/P.

Question 4

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 5

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 6

Use the following to answer questions :
Exhibit: Rental Price of Capital
(Exhibit: Rental Price of Capital) Based on the graph, if the capital market is initially in equilibrium at A with real rental price R₃/P and capital stock K₂, then holding other factors constant, an increase in the capital stock to K₃ will change the real rental price of capital to:

A) R₁/P.
B) R₂/P.
C) R₄/P.
D) R₅/P.

Question 7

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.

Question 8

Use the following to answer questions :
Exhibit: Rental Price of Capital
(Exhibit: Rental Price of Capital) Based on the graph, if the capital market is initially in equilibrium at A with real rental price R₃/P and capital stock K₂, then holding other factors constant, an improvement in technology that increases the marginal productivity of capital will move:

A) the demand curve from D₂ to D₁.
B) the demand curve from D₂ to D₃.
C) the supply of capital from K₂ to K₁.
D) the supply of capital from K₂ to K₃.

Question 9

Business fixed investment includes:

A) rental housing that landlords buy to rent out.
B) goods that 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 10

The cost of capital for investment, if the price of capital goods rises with the price of other goods and in the absence of taxes, may be summarized as the:

A) nominal interest rate plus the depreciation rate.
B) real interest rate plus the depreciation rate.
C) purchase price of a capital good multiplied by the sum of the nominal interest rate plus the depreciation rate.
D) purchase price of a capital good multiplied by the sum of the real interest rate plus the depreciation rate.

Question 11

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 12

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 13

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 14

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 15

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.

Question 16

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 17

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 18

The construction of a new shopping center is an example of:

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

Question 19

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.

Question 20

The most volatile component of real GDP is:

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

Question 21

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 22

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 23

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 24

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 25

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 26

When the capital stock reaches a steady state, the:

A) marginal product of capital must exceed the real cost of capital.
B) marginal product of capital must equal the real cost of capital.
C) real cost of capital must exceed the marginal product of capital.
D) real cost of capital must exceed the real rental price of capital.

Question 27

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 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

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 30

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 31

Net investment is the:

A) business fixed investment minus inventory investment.
B) change in the stock of capital.
C) gross investment minus the rate of inflation.
D) gross investment plus the replacement of depreciated capital.

Question 32

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

Question 33

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 34

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 35

______ 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 36

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 37

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 38

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 39

The function showing total spending on investment would be shifted inward and to the left by:

A) a technological innovation that increases the production function parameter A.
B) any event that raises the marginal product of capital.
C) any event that raises the purchase price of capital.
D) an accident that destroyed one-quarter of the U.S. capital stock while leaving the labor supply intact.

Question 40

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 41

During a financial crisis, such as the Great Depression or the recession of 2008-09, financing constraints become ______ prevalent and investment spending ______.

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

Question 42

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 43

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 44

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 45

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 46

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 47

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 48

Analogous to the role of expected profits from owning installed capital in the q theory of business fixed investment is the role played by the _____ in the model of the housing market.

A) real interest rate
B) nominal interest rate
C) expected imputed rent from owning housing
D) stock of existing housing

Question 49

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 50

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

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

Question 51

According to the efficient markets 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 52

According to the efficient markets 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 53

Use the following to answer questions :
Exhibit: Residential Investment
(Exhibit: Residential Investment) Based on the graph, if the capital market is initially in equilibrium at A with the relative price of housing equal to P_H3/P and the stock of housing capital equal to K_H2, then holding other factors constant, an economic recession that reduces national income will cause the relative price of housing to move to ______ and the flow of residential housing to move to ______.

A) P_H1/P; I_H4
B) P_H2/P; I_H3
C) P_H3/P; I_H2
D) P_H4/P; I_H1

Question 54

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 55

The link between the flow of new housing and the stock of existing housing is the:

A) relative price of housing.
B) demand for housing.
C) demand for residential investment.
D) real interest rate.

Question 56

According to the efficient markets 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 57

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 58

Residential investment equals the:

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

Question 59

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

Question 60

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 61

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 62

Inventory investment is the ______ component of aggregate spending and is very ______.

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

Question 63

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 64

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 paying wages to labor.
D) when a product is only partly completed, its components are counted as part of the firm's inventory.

Question 65

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 process

Question 66

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 67

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 process

Question 68

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 69

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 70

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

A) consumption spending.
B) net foreign investment.
C) government spending.
D) inventory investment.

Question 71

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 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

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 74

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 75

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 76

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 77

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 78

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 79

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

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

Question 80

Use the following to answer questions :
Exhibit: Residential Investment
(Exhibit: Residential Investment) Based on the graph, if the capital market is initially in equilibrium at A with the relative price of housing equal to P_H3/P and the stock of housing capital equal to K_H2, then holding other factors constant, if a massive earthquake destroys a significant portion of the stock of housing capital, house prices will move to ______ and the flow of residential housing will move to______.

A) P_H1/P; I_H4
B) P_H2/P; I_H3
C) P_H3/P; I_H2
D) P_H4/P; I_H1