Question 1

Since the 1970s _______ saving in the U.S. has been positive while _______ saving has been generally negative:

Accepted Answer

Since 1970, private savings have been positive, in large part due to business savings, while public savings have mostly been negative.

Question 2

The real rate of interest measures the ______ of capital investment.

Accepted Answer

The real rate of interest, which is adjusted for inflation, measures the value of other opportunities that are given up when funds are used for capital investment.

Question 3

An entrepreneur is considering how many limousines to purchase when he starts up a limousine service. Below are his estimates of the number of limousine rentals the service will make during a year, depending on the number of limousines available.  After paying all non-interest expenses, the owner expects to net $10 per rental. Each limousine costs $50,000. How many limousines should he purchase if the real interest rate is 6.5%?

Accepted Answer

Since the additional number of rentals (marginal product), is diminishing when more limousines are purchased, the value of the marginal product is also diminishing. While the first limousine adds 350 rentals per year (350 - 0), the second limousine adds only 300 rentals per year (650 - 350) and so forth. The marginal value of marginal product is therefore: $3,500 for the first limousine (350 × $10), $3,000 for the second limousine (300 × $10), $2,500 for the third limousine (250 × $10), $2,000 for the fourth limousine (200 × $10), and $1,500 for the fifth and final limousine (150 × $10). Since the annual interest cost of each limousine is $3,250 (6.5% × $50,000), the value of marginal product exceeds $3,250 for only the first limousine but not for the second one, so only 1 limousine should be purchased.

Question 4

The opportunity cost of capital investment is the:

Accepted Answer

When a firm makes capital investments, it faces an opportunity cost because the money invested cannot be lent out to others.

Question 5

Investment is a(n) ______ that changes the ______ of capital.

Accepted Answer

Investment is a "flow" of productive inputs because investments are made over time. After investment occurs, the "stock" of capital is changed. The greater the flow of investment is, the greater the increase in the stock of capital will be.

Question 6

The expected benefit of investment equals:

Accepted Answer

Firms investments are based on the marginal contribution to output and the price for which that output sells, which is known as the value of the marginal product of capital.

Question 7

The value of the marginal product of new capital increases when the:

Accepted Answer

When capital productivity increases, the value of the marginal product of capital increases because the new capital can produce more goods or services for a firm.

Question 8

Joe's Taco Hut can purchase a delivery truck for $20,000 and Joe estimates it will generate a net income (after taxes, maintenance and operating costs) of $4,000 per year. His other option is to go to work for someone else earning net income of $3,000 per year. He should:

Accepted Answer

If Joe purchases the delivery truck, he will earn $4,000. To be equally well off working for somebody else (his opportunity cost), he would have to earn $3,000 per year and still be able to cover the real interest for the van. With earnings of $4,000 and an opportunity cost of his time of $3,000 his borrowing costs must only be $1,000. $1,000 / $20,000 = 0.05 = 5%.

Question 9

The marginal product of new capital depends on ______ and _____.

Accepted Answer

When a firm considers new investments, they evaluate how much the investment increases output and how much new output can be sold for.

Question 10

An entrepreneur is considering how many limousines to purchase when he starts up a limousine service. Below are his estimates of the number of limousine rentals the service will make during a year, depending on the number of limousines available.  After paying all non-interest expenses, the owner expects to net $10 per rental. Each limousine costs $50,000. How many limousines should he purchase if the real interest rate is 5.5%?

Accepted Answer

Since the additional number of rentals (marginal product), is diminishing when more limousines are purchased, the value of the marginal product is also diminishing. While the first limousine adds 350 rentals per year (350 - 0), the second limousine adds only 300 rentals per year (650 - 350) and so forth. The marginal value of marginal product is therefore: $3,500 for the first limousine (350 × $10), $3,000 for the second limousine (300 × $10), $2,500 for the third limousine (250 × $10), $2,000 for the fourth limousine (200 × $10), and $1,500 for the fifth and final limousine (150 × $10). Since the annual interest cost of each limousine is $2,750 (5.5% × $50,000), the value of marginal product exceeds $2,750 for the first two limousines but not for the third, so 2 limousines should be purchased.

Question 11

From a macroeconomic perspective, the problem of low household saving has probably been overstated because:

Accepted Answer

U.S. household savings rates have fallen in the past 20 years. But if government or business saving picks up the slack, the national saving rate could be unaffected by falling household saving.

Question 12

Firms will invest in new equipment whenever:

Accepted Answer

Firms do a cost-benefit comparison before they buy new equipment. If the benefits exceed the costs, firms invest in new equipment.

Question 13

If consumption spending increases by $10 million with no changes in net taxes, then:

Accepted Answer

Household saving is a sub-category of private saving. If consumption spending goes up with income constant, then household saving must go down. In this case, private saving goes down by $10 million.

Question 14

An entrepreneur is considering how many limousines to purchase when he starts up a limousine service. Below are his estimates of the number of limousine rentals the service will make during a year, depending on the number of limousines available.  After paying all non-interest expenses, the owner expects to net $10 per rental. Each limousine costs $50,000. How many limousines should he purchase if the real interest rate is 4.5%?

Accepted Answer

Since the additional number of rentals (marginal product), is diminishing when more limousines are purchased, the value of the marginal product is also diminishing. While the first limousine adds 350 rentals per year (350 - 0), the second limousine adds only 300 rentals per year (650 - 350) and so forth. The marginal value of marginal product is therefore: $3,500 for the first limousine (350 × $10), $3,000 for the second limousine (300 × $10), $2,500 for the third limousine (250 × $10), $2,000 for the fourth limousine (200 × $10), and $1,500 for the fifth and final limousine (150 × $10). Since the annual interest cost of each limousine is $2,250 (4.5% × $50,000), the value of marginal product exceeds $2,250 for the first three limousines but not for the fourth, so 3 limousines should be purchased.

Question 15

Frank Murphy is considering how many snowmobiles to purchase for his snowmobile rental business. Below are his estimates of the number of snowmobile rentals per year, depending on the number of snowmobiles available.  After paying all non-interest expenses, expenses Frank expects to net $10 per rental. Each snowmobile costs $15,000. How many snowmobiles should Frank purchase if the real interest rate is 5.5%?

Accepted Answer

Since the additional number of rentals (marginal product), is diminishing when more snowmobiles are purchased, the value of the marginal product is also diminishing. While the first snowmobile adds 90 rentals per year (90 - 0), the second snowmobile adds only 80 rentals per year (170 - 90) and so forth. The marginal value of marginal product is therefore: $900 for the first snowmobile (90 × $10), $800 for the second snowmobile (80 × $10), $700 for the third snowmobile (70 × $10), $600 for the fourth snowmobile (60 × $10), and $500 for the fifth and final snowmobile (50 × $10). Since the annual interest cost of each snowmobile is $825 (5.5% × $15,000), the value of marginal product exceeds $825 for only the first snowmobile but not for the second one, so only 1 snowmobile should be purchased.

Question 16

Joe's Taco Hut can purchase a delivery truck for $20,000 and Joe estimates it will generate a net income (after taxes, maintenance and operating costs) of $2,000 per year. He has no other opportunities. He should:

Accepted Answer

If Joe purchases the delivery truck, he will earn 10% per year, i.e., $2,000/$20,000 = 0.10. If he can borrow money at a rate less than 10%, he will gain from buying the truck.

Question 17

From a microeconomic perspective, the relatively low U.S. household saving rate contributes to an increasing inequality of wealth resulting from:

Accepted Answer

U.S. household savings rates have fallen in the past 20 years. From a microeconomic perspective this signals growing inequality as lower-income families have lower savings rates than economically better-off households and very little wealth.

Question 18

The costs of investment depend on the ______ and the _______.

Accepted Answer

When firms consider new investments, they evaluate the cost or price of the new capital and the rate of interest on the loan taken to fund the capital investment.

Question 19

By international standards, the household saving rate of the United States:

Accepted Answer

National saving (S) equals Y - C - G. Since Y = C + I + G, we can substitute for Y in the equation, and S = C + I + G - C - G = I, so S = I.

Question 20

In the United States from 1960 to 2010, the largest positive contribution to national saving was from:

Accepted Answer

Business saving, sometimes from unplanned inventories, accounted for the bulk of national savings from 1960-2010.

Quiz 8: Saving and Capital Formation

Since the 1970s _ saving in the U.S. has been positive while _ saving has been generally negative: