Microeconomics – 10. The Capital Market, Interest, and Profits

  1. On a personal level, what kinds of questions can capital analysis help us answer?
  2. At a professional level, capital analysis can help business executives answer what kinds of questions?
  3. What are the three categories of capital goods?
  4. What do we mean by loanable funds? What is the price paid for the use of loanable funds?
  5. Suppose a company buys a used car for $10,000, rents it out for $2,500 per year and earns a net rental of $1200 each year after expenses. What is the rate of return?
  6. Define depreciation.
  7. The theory of loanable funds is based on what assumption? The upward sloping supply curve of loanable funds reflects what idea?
  8. The market interest rate serves what two functions?
  9. Suppose the Federal government significantly expands the Social Security retirement program to cover more fully the costs of hospitalization and retirement. What is this likely to do to the supply curve for loanable funds and the market rate of interest?
  10. Suppose the economy had been in a deep recession, but is moving now towards full employment. What will happen to the interest rate, and why?
  11. How do you evaluate an investment when your capital outlay occurs today but the benefits from that investment come in the form of a revenue stream over many years?
  12. How is net present value defined and measured? What lump sum of money today would make you at least as well off as the stream of rental payments that you would get over the life of the building?
  13. What is a perpetuity? Write the formula to evaluate a perpetuity.
  14. Write the general formula for calculating net present value.
  15. Suppose you have a choice between a new, energy-efficient refrigerator which costs $750 or the cheaper model at $500. If you buy the energy-efficient refrigerator, your electricity bill will be $120 a year less over the 5-year life of the refrigerator. Assuming an interest rate of 8 percent, which refrigerator should you buy?
  16. To what does the “term structure of interest rates” refer?
  17. How do risk premium, length of maturity, loan size, and taxability each affect the interest rate?
  18. Show how, by sacrificing current consumption and building capital goods today, societies can increase their consumption in the future.

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