Q: Suppose $$K_t = 100$$, $$K^* = 120$$, and $$d = 0.05. $$What is the desired investment $$I_t^d$$?

$$I_t^d = 120 - (1 - 0.05) \times 100 = 120 - 95 = 25$$

Question 1

Which of the following best describes the user cost of capital ($$uc) in $$the basic investment model?

Accepted Answer

$$uc = (r + d) p_K$$

Question 2

According to the basic model, the desired capital stock $$K^* is $$determined by which condition?

Accepted Answer

$$MPK^f = uc$$

Question 3

If the real interest rate $$r$$ increases, what happens to the user cost of capital and the desired capital stock, all else equal?

Accepted Answer

User cost of capital increases and desired capital stock decreases

Question 4

Suppose the effective tax rate on capital, $$	au$$, increases. According to the tax-adjusted user cost formula, what is the new condition for the desired capital stock?

Accepted Answer

$$MPK^f = \dfrac{uc}{1-	au}$$

Question 5

Refer to the first graph provided. What does the intersection of the $$MPK^f$$ curve and the $$uc_1$$ line represent?

Accepted Answer

The profit-maximizing (desired) capital stock $$K_1$$^*$$

Question 6

If the depreciation rate $$d$$ increases, what is the effect on the user cost of capital and the desired capital stock?

Accepted Answer

User cost of capital increases, desired capital stock decreases

Question 7

Which of the following best explains why investment is more volatile than consumption over the business cycle?

Accepted Answer

Investment is sensitive to changes in interest rates and expectations, causing larger fluctuations

Question 8

Based on the third image, what trend is observed in Canada’s Marginal Effective Tax Rate (METR) on investment from 2000 to 2019?

Accepted Answer

The METR has declined significantly

Question 9

Suppose a country’s METR is higher than the G7 average. What is the likely effect on its desired capital stock, all else equal?

Accepted Answer

The desired capital stock will be lower

Question 10

If technology improves, causing the $$MPK^f$$ curve to shift upward, what happens to the desired capital stock $$K^*$$?

Accepted Answer

$$K^*$$ increases

Question 11

Given the investment dynamics equation $$K_{t+1} - K_t = I_t - d K_t$$, what does $$I_t$$ represent?

Accepted Answer

Gross investment in period $$t$$

Question 12

If the real price of capital goods $$p_K$$ rises, what is the effect on the user cost of capital and the desired capital stock?

Accepted Answer

User cost of capital increases, desired capital stock decreases

Question 13

Refer to the second graph. What does the shift from $$uc_1 to$$ $$uc_2$$ illustrate?

Accepted Answer

An increase in the user cost of capital, leading to a lower desired capital stock

Question 14

Which of the following is NOT a component of the user cost of capital?

Accepted Answer

Marginal product of capital

Question 15

If a firm faces a higher effective tax rate on capital, what happens to the after-tax return on capital?

Accepted Answer

The after-tax return decreases

Question 16

Suppose $$K_t = 100$$, $$K^* = 120$$, and $$d = 0.05. $$What is the desired investment $$I_t^d$$?

Accepted Answer

$$I_t^d = 120 - (1 - 0.05) 	imes 100 = 120 - 95 = 25$$

Question 17

Which of the following best describes the relationship between savings and investment in the context of physical capital?

Accepted Answer

Savings provide the funds used for investment in physical capital

Question 18

Based on the fourth image, how does Canada’s METR in 2019 compare to other G7 countries?

Accepted Answer

Canada’s METR is the lowest among G7 countries

Investment in Macroeconomics: Determinants, Dynamics, and Taxation

Study Guide - Practice Questions

Study Guide - Flashcards