Lec10 iC Questions Flashcards
Consider a consumer with a consumption function of $5000 + 0.8*Income.
At what income level are savings equal to zero?
(Answer to 1 decimal point)
Y = C + S
S = Y - C = 0
Y = C
C = 5000 + 0.8Y
Y = 5000 + 0.8Y
Y = $25,000
Which of the following will cause the consumption function to shift down?
a) A reduction in current income
b) An increase in current income
c) An increase in wealth
d) An increase in consumer optimism about future income
e) An increase in interest rates
e) An increase in interest rates
Which of the following would count positively as investment spending when measuring GDP?
a) A household buys a new car
b) A business buys material to be used in production of consumption goods this month
c) The government builds a new airport
d) A household buys a 20-year-old house
e) A construction firm buys new tools for their workers
e) A construction firm buys new tools for their workers
An investment will return $5,000 in one year, and then an additional $5,000 in two years. If the nominal interest rate on similarly risky investments is 6%, what is the present value of this investment?
(Answer to 1 decimal point)
PV = FV/(1.06)^1 + FV/(1.06)^2
PV = 5000/(1.06)^1 + 5000/(1.06)^2
PV = $9167
You invest $1,000 in an account that pays a nominal return of 5%. The expected inflation rate is 2%. In terms of current purchasing power, how much will this investment be worth in 15 years?
(Answer to the nearest dollar)
FV (nominal) = PV(1+r)^t
FV (nominal) = 1000(1.05)^15
FV (nominal) = 2079
2079 X 1/(1.02)^15
= $1545
FV (real) = PV(1+r)^t
FV (real) = 1000(1.02)^15
FV (real) = $1558
Either method works
A company is deciding whether to invest in new equipment that will cost $6,000,000. If they invest the equipment will generate $500,000 in net revenue in the first year, and productivity declines by 4% in each subsequent year. The inflation rate of output is 2%.
What is the maximum nominal interest rate at which it is worth investing in the equipment?
PV = (Next Year’s Revenue)/(Nom-Inflation + Depreciation)
PV = 500000 / (Nom - 2% + 4%) ≥ 6,000,000
(500000 - 120000)/6000000 ≥ Nominal Rate
6.33% ≥ Nominal Rate
Maximum Nominal Rate is 6.33%
The economy initial has a nominal interest rate of 5% while expected inflation is 2%. If the nominal interest rate increases to 6%, while inflation increases to 4%, what will happen to total investment in the economy (all else equal)?
a) Investment decreases
b) No change in investment
c) Investment increases
d) The effect on investment is uncertain
e) None of the above
c) Investment increases
From 1980 to 2019, the long-run real interest rate fell from 7% to roughly 0%. Which of the following is the most likely cause of this fall?
a) An increase in budget defecits
b) An aging population moved into the “saving time in the life-cycle
c) Average incomes increased, leading to higher savings rates
d) Business optimism regarding future revenues increased
e) Business tax rates fall
b) An aging population moved into the “saving time in the life-cycle
c) also works but b) is the better answer
As the baby boom generation reaches retirement, they will move into a period of dis-saving. What would be the likely effect on interest rates and total investment?
a) Real interest rates fall and investment falls
b) Real interest rates fall and investment rises
c) Real interest rates rise and investment falls
d) Real interest rates rise and investment rises
e) None of the above
c) Real interest rates rise and investment falls
