David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

Review questions
the quantity of capital relative to labour, and a corresponding fall in the ratio of capital rentals to
labour wages.
• The personal distribution of income shows how national income is divided between different
individuals regardless of the factor services from which income is earned. A major cause of income
inequality in the UK is a very unequal distribution of income-earning wealth.
Review questions
(a) Consumer durables such as washing machines are part of the capital stock but do not generate
any financial income for their owners. Why do we include consumer durables in the capital stock?
(b) To wash your clothes you can take them to a launderette and spend £2 per week indefinitely or
buy a washing machine for £400. It costs £1 per week (including depreciation) to run a washing
machine, and the interest rate is 10 per cent per annum. Does it make sense to buy the washing
machine? Does this help you answer part (a)?
2 A bank offers you £1.10 next year for every £0.90 you give it today. What is the implicit interest
rate?
3 A firm buys a machine for £10 000, earns rentals of £3600 for each of the next two years, and then
sells it for scrap for £9000. Use the data of Table 11.4 to determine if the machine is worth buying
when the interest rate is 10 per cent per annum.
4 The interest rate falls from 10 per cent to 5 per cent. Discuss in detail how this affects the rental on
capital services and the level of the capital stock in an industry in the short and the long run.
5 Suppose a plot ofland is suitable only for agriculture. Can the farming industry experience financial
distress if there is an increase in the price of land? Is your answer affected if the land can also be
used for housing?
6 Common fallacies Why are these statements wrong? (a) Inflation leads to high nominal interest
rates. This reduces the present value of future income. (b) If the economy continues to become
more capital intensive, eventually there will be no jobs left for workers to do. ( c) Since the economy's
supply of land is fixed, it would be supplied even at a zero rental, which should therefore be the
equilibrium rental in the long run.
7 Suppose you face the following two investment opportunities: (i) You can invest £3000 and after
five years you are going to get £4500. (ii) You can invest your £3000 at the annual market interest
rate of 10 per cent for five years. Which investment will you make? Demonstrate your answer by
comparing the present values of the two investment opportunities.
8 Suppose that the demand for capital is given by K = 20 - 2r, where K denotes capital and r is the
rental rate. In a graph with r on the vertical axis and K on the horizontal axis, plot the demand
for capital. Suppose that in the short run the supply of capital is fixed at 6. In a graph show how the
rental rate is determined in equilibrium. An earthquake destroys part of the capital available in the
economy. The supply of capital shrinks to 4 in the short run. What happens to the equilibrium
rental rate?
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