SUBJECT: MACROECONOMICS (ECO 303)

INSTRUCTOR: ANUM ELLAHI MAZHAR

NAME_________________________ SECTION________________________
PROBLEM SET 4

1) If an economy has achieved its desired capital stock and wishes merely to maintain it, should any
investment occur? If not, why not? If so, how much?
2) 2. What effect has the recent shift toward investment in high-tech capital goods had on the rate of
depreciation? Do you think there is a rate of depreciation associated with the stock of human capital?
3) 3. If a firm invests out of retained profits rather than borrowed funds, will its investment decisions still
be affected by the changes in the interest rate? Explain.
4) 4. The model of business fixed investment studied examines the benefits and costs to firms of owning
capital goods. Its basic conclusion is that firms will increase their capital stock as long as the marginal
product of their capital exceeds the marginal cost. What is Tobin’s q , and how does it relate to the
model(business fixed)
5) Suppose that an explicitly temporary tax credit is enacted. The tax credit is at the rate of 10 percent and
lasts only one year.
a. What is the effect of this tax measure on investment in the long run (say, after four or five
years)?
b. What is the effect in the current year and in the following year?
c. How would your answers in ( a ) and ( b ) differ if the tax credit were permanent?
6) Given the following information, calculate Tobin’s q statistic: Let’s suppose that a company has one
million outstanding shares of stock, each valued at $25. Let us suppose also that the replacement cost of
its physical capital stock is $18 million.
a. Should this firm invest (net) in more physical capital?
b. Would your answer change if the replacement cost of its physical capital stock at this time was
$25 million? $28 million?
7) Show the effect of contraction fiscal policy in (domestic) on I, S, ε and NX
8) Show the effect of contraction fiscal policy in (foreign) on I, S, ε and NX
9) Show the effect of an increase in investment demand on I, S, ε and NX
10) Show the effect of trade policy to restrict imports on I, S, ε and NX