If the real interest rates are higher than the marginal productivity of capital (MPK) what will...

Question:

If the real interest rates are higher than the marginal productivity of capital (MPK) what will we expect in the short run?

a. Firms will invest more and over time the stock of capital will rise, bringing MPK down

b. Firms will invest less and over time the stock of capital will decrease, increasing MPK

c. Firms will invest less and over time the stock of capital will decrease, bringing MPK down

d. Firms will invest more and over time the stock of capital will rise, increasing MPK

Investment Demand:

Firms have a demand for capital just like households have a demand for goods and services. The price firms pay for capital is called the real interest rate and the benefit from capital is called the marginal return on capital, or sometimes the marginal productivity of capital. All other things equal, capital markets will adjust output until the cost equals the benefit, or the interest rate equals the marginal return.

Answer and Explanation:

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The answer is (b), since the price of capital exceeds the benefit, firms will decrease their capital purchases. Because the MPK diminishes as...

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Required Return vs. Cost of Capital

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Chapter 14 / Lesson 1
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Let's take a look at how required return and cost of capital each offer different perspectives in figuring out the opportunity cost of different investment decisions.


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