Capital, Investment, and Economic Growth: Practice Questions and Solutions

Problem 66. Which of these is a possible way of formulating the cost of capital?

(a) Cost of capital = depreciation + replenishment costs
(b) Cost of capital = depreciation + opportunity costs
(c) Cost of capital = market rate of interest + risk premium
(d) Cost of capital = depreciation + risk premium
(e) Cost of capital = market rate of interest + opportunity costs

Solution 66. A possible way of formulating the cost of capital is
(b): Cost of capital = depreciation + opportunity costs

Problem 67. What is a possible way of formulating the opportunity costs of capital?

(a) Opportunity costs = maintenance costs + replenishment costs
(b) Opportunity costs = market rate of interest
(c) Opportunity costs = market rate of interest + risk premium
(d) Opportunity costs = depreciation + risk premium
(e) Opportunity costs = market rate of interest + depreciation

Solution 67. A possible way of formulating the opportunity costs of capital is
(c): Opportunity costs = market rate of interest + risk premium

Problem 68. Which of these statements about capital and interest rates are correct?
(a) In a market without institutional barriers and information asymmetries, the costs of internal finance to a company should be the same as the costs of external finance.
(b) Labor is the factor which most accurately explains differences in output among the countries of the world.
(c) Lower interest rates correspond with high levels of investment in capital.
(d) Higher interest rates correspond with lower levels of savings.
(e) In the long run and at the aggregated level, savings S can be expected to be equal to investment I.

Solution 68. The following statements are correct:
(a): In a market without institutional barriers and information asymmetries, the costs of internal finance to a company should be the same as the costs of external finance.
(c): Lower interest rates correspond with high levels of investment in capital.
(e): In the long run and at the aggregated level, savings S can be expected to be equal to investment I.

Problem 69. Which of these statements about investment and economic growth are correct?

(a) Net investment can be expressed as follows:
Net investment = Gross investment + Depreciation
(b) Net investment can be expressed as follows:
Net investment = Gross investment - Depreciation
(c) Increases in investment are ultimately financed through increases in savings.
(d) For richer countries, increases in total factor productivity are the primary driving force of economic growth, whereas for poorer countries, increases in the capital stock are more important.
(e) If depreciation exceeds gross investment, a country's capital stock will grow.
(f) The term "absolute convergence" describes standards of living among countries becoming increasingly similar until no difference exists.
(g) Absolute convergence requires poorer countries to grow faster than richer countries.

Solution 69. The following statements are correct:

(b): Net investment can be expressed as follows:
Net investment = Gross investment - Depreciation
(c): Increases in investment are ultimately financed through increases in savings.
(d): For richer countries, increases in total factor productivity are the primary driving force of economic growth, whereas for poorer countries, increases in the capital stock are more important.
(f): The term "absolute convergence" describes standards of living among countries becoming increasingly similar until no difference exists.
(g): Absolute convergence requires poorer countries to grow faster than richer countries.

Problem 70. Which of these are reasons or conditions explaining why the Solow growth model predicts absolute convergence for countries?

(a) Absolute convergence in the Solow model holds because of the assumption that all countries will have the same rates of savings, access to technology, and population growth rates.

(b) According to the Solow model, there are increasing returns to scale from technological innovations and capital stock increases.
(c) According to the Solow model, countries will converge on their balanced growth paths.
(d) According to the Solow model, the rate of return on capital is lower in countries with more capital per worker.
(e) According to the Solow model, population growth in richer countries will eventually slow economic growth to a crawl, giving the poorer countries an opportunity to catch up without increasing their capital stock or access to technology.
(f) As poor countries gain access to new methods of technology, differences in technology and knowledge between rich countries and poor countries will shrink.
(g) The Solow growth model holds that institutions in all countries will eventually mirror those of the West, leading to a better institutional climate for growth.

Solution 70. The following are reasons or conditions explaining why the Solow growth model predicts absolute convergence for countries:

(a): Absolute convergence in the Solow model holds because of the assumption that all countries will have the same rates of savings, access to technology, and population growth rates.
(c): According to the Solow model, countries will converge on their balanced growth paths.
(d): According to the Solow model, the rate of return on capital is lower in countries with more capital per worker.
(f): As poor countries gain access to new methods of technology, differences in technology and knowledge between rich countries and poor countries will shrink.

See Mr. Stolyarov's complete index of Intermediate Macroeconomics Problems and Solutions here.