King: Economics

Chapter 15: Land and Capital

Correct answers are marked with an asterisk*

Type: multiple choice question

Title: Chapter 15 - Question 01
01) A firm that is seeking to maximize profits will hire more capital if:
a. the marginal revenue product of capital is less than its marginal cost.
Feedback: No this is incorrect because if MRP of capital is less than MC, the firm will
benefit by using one less unit of capital. The firm’s profits will rise if the firm uses one less
unit of capital.
Page reference: 321
*b. The marginal revenue product of capital is greater than its marginal cost.
Feedback: This is correct because if MRP of capital is greater than MC, the firm will
benefit by using one more unit of capital. The firm’s profits will rise if the firm uses one
more unit of capital.
Page reference: 321
c. The marginal revenue product of labour is positive.
Feedback: This is incorrect as if MRP of labour is positive we cannot deduce anything
about profits from hiring more capital.
Page reference: 321
d. The marginal revenue product of capital is equal to its marginal cost.
Feedback: This is not correct because if MRP of capital is equal to its MC, then the firm
would not gain by employing more capital since this is the best point of the firm.
Page reference: 321

Type: multiple choice question

Title: Chapter 15 - Question 02
02) Suppose Jim bought a machine that costs £5,000 which will give him returns of £2000
after taking expenses into account for each of the next three years. What is the net
present value of the machine if the rate of interest on a risk-free loan is 5%?
a. £ 387.53
Feedback: This is not correct since NPV = sum of present values minus cost of machine.
Page reference: 325
*b. £ 446.53
Feedback: NPV = (2000/1.05) + (2000/1.05)squared + (2000/1.05)cubed minus £5000;
NPV = (1904.762 + 1814.059 + 1727.713) – 5000
NPV = 5446.533 – 5000 = 446.533
Page reference: 325
c. £ 466.53
Feedback: This is not correct since NPV = sum of present values minus cost of machine.
Page reference: 325
d. £ 664.53
Feedback: This is not correct since NPV = sum of present values minus cost of machine.
Page reference: 325

Type: multiple choice question

Title: Chapter 15 - Question 03
03) When the return to a factor of production is greater than is required to supply that
factor then we have:

© Oxford University Press, 2012. All rights reserved.

 King: Economics
Chapter 15: Land and Capital

a. interest.
Feedback: No, this is not correct as interest is not applicable in this case.
Page reference: 323
*b. economic rent.
Feedback: This is correct because economic rent is the returns that are above that which
is required to supply that input.
Page reference: 323
c. transfer earning.
Feedback: This is incorrect as transfer earnings are the amount required to supply an
input.
Page reference: 323
d. marginal revenue product.
Feedback: This is incorrect, MRP is the addition to total revenue from employing one
more unit of input.
Page reference: 323

Type: multiple choice question

Title: Chapter 15 - Question 04
04) Which one of the following is an example of an exhaustible resource?
a. Land
Feedback: This is not correct because land remains more or less fixed from usage.
Page reference: 301
*b. Iron ore
Feedback: This is correct because iron ore resources get depleted once they are
extracted and not replaced.
Page reference: 301
c. Forest
Feedback: This is not correct because the forest can be replenished.
Page reference: 301
d. Ocean
Feedback: This is incorrect because the ocean is not depleted through usage.
Page reference: 301

Type: multiple choice question

Title: Chapter 15 - Question 05
05) Which one of the following would cause the net present value of an asset to rise over
time?
a. A fall in the productivity of the asset.
Feedback: This is incorrect because if the productivity of the asset falls then the NPV
falls.
Page reference: 326
*b. A decrease in the risk-free lending rate.
Feedback: This is true as if the risk-free lending rate falls then the discount rate becomes
lower and the NPV increases which in turn makes a profitable project seem less profitable.
Page reference: 326
c. A rise in the risk-free lending rate.
Feedback: This is incorrect since a rise in the risk-free lending rate would make the asset
less attractive.
Page reference: 326

© Oxford University Press, 2012. All rights reserved.

 King: Economics
Chapter 15: Land and Capital

d. A rise in the price of other inputs which are utilized with the asset.
Feedback: No, this is not right because if the price of other inputs utilized with the asset
rise then the returns will fall and the NPV will fall.
Page reference: 326

Type: multiple choice question

Title: Chapter 15 - Question 06
06) According to the Hotelling rule, the rate of extraction of the stock of a renewable
resource will be where:
a. the expected rise in the price of the non-renewable resource is at a rate lower than the
marginal revenue product.
Feedback: No, this is not correct as it is not the Hotelling rule. The statement itself is
hardly sensible.
Page reference: 330
*b. The expected rise in the price of the non-renewable resource minus the extraction
costs is at a rate equal to the interest rate.
Feedback: Yes this is correct because the Hotelling rule says that the rate of extraction of
a resource is where the expected rise in the price of the resource is at a rate equal to the
interest rate.
Page reference: 330
c. The expected rise in the price of the exhaustible resource minus the extraction costs is
at a rate below the interest rate.
Feedback: No, this is not correct because if the expected rise in the price of a non-
renewable resource is at a rate below the interest rate then the Hotelling rule would not
hold.
Page reference: 330
d. The expected rise in the price of the non-renewable resource is at a rate that is equal to
the marginal revenue product.
Feedback: No, this is not correct as it is not what the Hotelling rule says.
Page reference: 330

Type: multiple choice question

Title: Chapter 15 - Question 07
07) Which one of the following is not an explanation of why the rate of increase in the
price of an exhaustible resource every year will not equal the interest rate?
a. Changes in extraction costs of resources.
Feedback: This is correct because if there are changes in extraction costs then the price
of a resource may not rise at a rate equal to the interest rate. Future prices may not reflect
the change in extraction costs. So this is not the right answer.
Page reference: 332
b. Changes in the demand for the resource.
Feedback: This is correct because if there are changes in demand then the price of a
resource may not rise at a rate equal to the interest rate. Future prices would start to fall if
demand falls. So this is not the right answer.
Page reference: 332
c. Discovery of new resource mines.
Feedback: This is correct because if new resource mines are discovered then the price of
a resource may not rise at a rate equal to the interest rate. Future prices would start to fall
as supply increases. So this is not the right answer.

© Oxford University Press, 2012. All rights reserved.

 King: Economics
Chapter 15: Land and Capital

Page reference: 332

*d. No change in the stock of the resource.
Feedback: If there is no change in the stock of the resource then the rate of increase in
the price of the resource will equal the interest rate. So this is not the right answer.
Page reference: 332

Type: multiple choice question

Title: Chapter 15 - Question 08
08) Which one of the following is seen as an opportunity cost of a person going into higher
education?
*a. The interest earned from accumulated savings from work forgone.
Feedback: This is correct because had the person not taken up higher studies then
he/she could have earned interest from savings accumulated from working.
Page reference: 308
b. Costs of fees and books.
Feedback: This is incorrect as the costs of fees and books are direct costs incurred by the
person in studies.
Page reference: 308
c. Income earned from part-time work undertaken during studies.
Feedback: This is not correct because the income earned from part-time work during
studies is not foregone income that would have been earned by not taking up studies.
Page reference: 308
d. The costs of taking private tuition to prepare for exams.
Feedback: No, this is incorrect because costs of private tuition are the costs incurred
during studies.
Page reference: 308

Type: multiple choice question

Title: Chapter 15 - Question 09
09) Suppose Sattie is planning to buy an Electrolux machine costing £1,500 for her
catering business which will yield revenue of £200 for each of the next five years. The risk-
free rate of interest is 4%. Should Sattie buy the machine?
a. NPV is £409.65, so Sattie should buy the machine.
Feedback: No, this is not correct as the NPV must be calculated to assess whether the
machine is worth buying. NPV = sum of present value of future earnings from the machine
minus the cost of the machine.
Page reference: 325
b. NPV is £609.65, so Sattie should buy the machine.
Feedback: This is not right since the NPV must be calculated to assess whether the
machine is worth buying. NPV = sum of present value of future earnings from the machine
minus the cost of the machine.
Page reference: 325
*c. NPV is -£609.65, so Sattie should not buy the machine.
Feedback: This is correct, since we need to calculate the NPV to determine whether
Sattie should buy the machine. NPV = sum of present values minus cost of machine;
NPV = [200/1.04 + (200/1.04)squared + (200/1.04)cubed + (200/1.04)raised to power of 4
+ (200/1.04)raised to power of 5] minus 1,500;
NPV = [192.308 + 184.911+ 177.794 + 170.955 + 164.379] minus 1,500
NPV = 890.35 – 1,500 = - 609.65. So Sattie is better off by not buying the machine.

© Oxford University Press, 2012. All rights reserved.

 King: Economics
Chapter 15: Land and Capital

Page reference: 325

d. NPV is -£409.65, so Sattie should not buy the machine.
Feedback: This is incorrect as the NPV must be calculated to assess whether the
machine is worth buying. NPV = sum of present value of future earnings from the machine
minus the cost of the machine.
Page reference: 325

Type: multiple choice question

Title: Chapter 15 - Question 10
10) Which one of the following is the correct net present value if Rebecca buys a machine
for £500 that is expected to yield revenue of £100 for each of the next three years and the
risk-free interest rate is 5%?
a. £327.67.
Feedback: This is incorrect since NPV is equal to the sum of the present values minus
the cost of the machine.
Page reference: 325
b. £327.67.
Feedback: This is incorrect since NPV is equal to the sum of the present values minus
the cost of the machine.
Page reference: 325
c. £227.67.
Feedback: This is incorrect since NPV is equal to the sum of the present values minus
the cost of the machine.
Page reference: 325
*d. - £227.67.
Feedback: This is the correct NPV which is equal to the sum of the present values minus
the cost of the machine.
NPV = [(100/1.05) + (100/1,05)squared + (100/1.05)cubed] minus 500
NPV = 95.238 + 90.703 + 86.386;
NPV = 272.33 – 500 = 227.67
Page reference: 325

© Oxford University Press, 2012. All rights reserved.