Neoclassical model of investment

Question 1

Neoclassical investment model shows how investment depends on:

Answer 1

• MPK
• DMP
• Interest rate
• Tax rules affecting firms

Question 2

What are the two types of firms in the NIM?

Answer 2

• Production firms

- Rental firms

Question 3

What do production firms do?

Answer 3

Rent capital to produce goods and services

Question 4

What do Rental firms do?

Answer 4

Own capital and rent it to production firms

Question 5

For production firms, the formula for Change in profit is:

Answer 5

P*MPK-R

Question 6

Reread over Cobb douglas production function

Answer 6

X

Question 7

What does the real cost of capital depend on?

Answer 7

• Relative price of capital
• Real interest rate
• Depreciation rate

Question 8

A firm’s net investment rate depends on:

Answer 8

Profit rate

Question 9

Profit rate =

Answer 9

MPK - (Pk/P)(r+δ)

Question 10

If profit rate > 0, then increasing K is:

Answer 10

profitable

Question 11

Net investment=

Answer 11

ΔK

Question 12

Rental firms invest in new capital when:

Answer 12

The benefit of doing so exceeds the cost

Question 13

What are the costs of capital?

Answer 13

• Interest cost
• Depreciation cost
• Capital loss

Question 14

How do you calculate interest cost?

Answer 14

i x Pk

Question 15

How do you calculate depreciation cost?

Answer 15

δ x Pk (δ = rate of depreciation)

Question 16

How do you calculate Capital loss?

Answer 16

-ΔPk

Question 17

What’s the nominal cost of capital?

Answer 17

Pk(r+δ)

Question 18

What is the formula for net investment?

Answer 18

In*Profit rate

Question 19

What is δ?

Answer 19

Rate of depreciation

Question 20

An increase in interest rate:

Answer 20

• Raises cost of capital
• Reduces the profit rate
• Reduces investment

Question 21

An increase in MPK:

Answer 21

• Increases the profit rate
• Increases investment at any given rate
• Shifts I curve to the right

Question 22

What are the two most important policies affecting investment?

Answer 22

• Corporate income tax

- Investment tax credit

Question 23

Corporate tax discourages Investment because:

Answer 23

• If Pk rises over time, the legal definition of profit Understates true cost and overstates profit
• It doesn’t measure economic profit (depreciation cost)

Question 24

What does ITC stand for?

Answer 24

Investment tax credit

Question 25

What does ITC do?

Answer 25

-Reduces a firm’s taxes by a certain amount for each dollar spent on capital

Question 26

Why does ITC increase the incentive to invest?

Answer 26

It reduces Pk, which increases the profit rate

Question 27

What’s the equation for Tobin’s q?

Answer 27

Market value of installed capital/Replacement cost of installed capital

Question 28

If Tobin’s q>1:

Answer 28

Firms buy more capital to raise the market value of their firms

Question 29

If Tobin’s q<1

Answer 29

Firms don’t replace capital as it wears out

Question 30

A wave of pessimism about future capital profitability would:

Answer 30

• Cause a fall in stock prices
• Cause tobin’s q to fall
• Shift the investment function down
• Cause a negative demand shock

Question 31

A fall in stock prices would:

Answer 31

• Reduce household wealth
• Shift consumption function down
• Cause a negative AD shock

Question 32

What are financing constraints?

Answer 32

Limits on the amounts that firms can borrow (or raise in financial markets)

Question 33

What’s the formula for MPK?

Answer 33

R/P

Question 34

What does pi mean?

Answer 34

inflation