CH 015

Chapter 15
Capital, Interest, and Profits
Multiple Choice Questions
1. Capital consist of:

A) those durable produced items that are in turn used as productive inputs for further production.
B) those durable produced items that are sold to consumers.
C) only those goods that are output.
D) goods sold at Walmart.
E) none of the above.
Answer: A
Difficulty: Easy
Topic: Definition
Bloom’s: Knowledge
AACSB: Reflective Thinking
2. Which of the following would be considered intangible capital?

A) software.
B) patents.
C) brand name.
D) all of the above.
Answer: D
Difficulty: Easy
Topic: Definition
3. The present value of a farm is $10,000. It pays $2000 per year in net income. The interest rate
per year must be:
A) 0 percent.
B) 5 percent.
C) 10 percent.
D) 15 percent.
E) 20 percent.
Answer: E
Difficulty: Medium
Topic: Numerical Analysis
Bloom’s: Application
AACSB: Analytic
4. Capital differs from other resources in that it:

A) is not used in socialist economies.
B) is not subject to diminishing returns.
C) cannot be augmented or exhausted.
D) is not a physical good.
E) is both an input and an output of the economy.
Answer: E
Difficulty: Easy
Topic: Definition
5. From society's viewpoint, a particular new investment project is always worthwhile if:
A) the cost of borrowing is very low.
B) the new project is more roundabout than the present method of production.
C) it will increase real GDP.
D) it will increase real NDP.
E) its rate of return is greater than the market rate of interest.
Answer: E
Difficulty: Medium
Topic: Simple Application
Bloom’s: Comprehension
6. A person who can save at 8 percent interest decided to subscribe to a magazine. A 1-year
subscription costs $12, a 2-year subscription $22. What is the cost to her of the second year?
A) $10.
B) $10.80.
C) $9.60.
D) $11.
E) $11.40.
Answer: B
Difficulty: Hard
AACSB: Analytic
7. If the rate of interest increases from 8 percent to 10 percent, the holder of a perpetuity which
yields $100 a year forever receives a capital:
A) loss of $40.
B) loss of $50.
C) gain of $50.
D) loss of $250.
E) gain of $250.
Answer: D
Difficulty: Hard
AACSB: Analytic
8. An individual who holds marketable government securities now is likely to sell them and hold
money instead if he believes that:
A) interest rates will fall far below present levels.
B) interest rates will fall below present levels for 3 months and then will rise above present
levels.
C) interest rates will soon rise far above present levels.
D) interest rates will not change from present levels.
E) a substantial price deflation is coming.
Answer: C
Difficulty: Hard
9. If net investment is positive, then:

A) the rate of interest (and the capital market) could still be in long-run equilibrium.
B) it is impossible to say whether the capital stock is growing, unless gross investment is also
known.
C) the capital stock is increasing, which might cause the interest rate to fall in the long run if the
greater capital is applied to fixed amounts of other factors.
D) the capital stock is increasing, causing the demand curve for capital to shift downward in the
long run and the interest rate to fall.
E) this could be a long-run equilibrium position, provided net saving is zero.
Answer: C
Difficulty: Medium
Topic: Definition
10. If capital has a computable rate of return, then we say that:

A) it is the yardstick against which most consumer loan applications are measured.
B) it is the time interval between future consumption goods and sacrificed present consumption
goods.
C) it is the technological factor which equates investment opportunities with people's impatience
to consume now.
D) employers should substitute capital for labor in current production processes.
E) none of the above are correct.
Answer: E
Difficulty: Hard
Topic: Definition
11. The rate of return on investment is:

A) the annual net return per dollar of invested capital.
B) the number of investments we do not accept.
C) the annual payment on money borrowed.
D) the monthly total return per dollar of invested capital.
Answer: A
Difficulty: Easy
Topic: Definition
12. When you buy a bond or put money in your savings account, the financial yield on this
investment is called:
A) rate of return on investment.
B) interest rate.
C) lending rate.
D) bond rate.
Answer: B
Difficulty: Easy
Topic: Definition
13. What is the dollar value today of a stream of income over time?
A) future value.
B) past value.
C) present value.
D) interest payment.
Answer: C
Difficulty: Easy
Topic: Definition
14. If the interest rate is 10% and you will receive $2000 next year and $3000 in three years, what is
the present value?
A) $5000.
B) $6000.
C) $5500.
D) $4075.
Answer: D
Difficulty: Medium
AACSB: Analytic
15. Why would asset prices tend to move inversely with interest rates?
A) their present value decreases as interest rates increase.
B) their present value increases as interest rates increase.
C) their past value decreases as interest rates increase.
D) prices tend to move the same as interest rates.
Answer: A
Difficulty: Medium
21. Nominal interest rate is:

A) the interest rate on money in terms of money.
B) the interest corrected for inflation.
C) not the interest rate.
D) return on investments in terms of real goods.
Answer: A
Difficulty: Easy
Topic: Definition
16. Real interest rate is:

A) the nominal interest rate minus inflation.
B) the interest rate including inflation.
C) not the interest rate.
D) return on investments in terms of real goods.
Answer: A
Difficulty: Easy
Topic: Definition
17. Which of the following is not associated with the concept of profit?
A) Rewards for risk-taking.
B) Rewards for innovation.
C) Monopoly returns.
D) Implicit returns to factors supplied by owners.
E) All of the above are related to the concept of profit.
Answer: E
Difficulty: Easy
Topic: Definition
18. The reward to an entrepreneur, as such, is called by economists:

A) windfall gain.
B) rent.
C) unearned increment.
D) monopoly profit.
E) profit.
Answer: E
Difficulty: Easy
Topic: Definition
19. For an economist normal business profits are:

A) a cost, because they represent payments necessary to keep the resources owned by the
entrepreneur in the enterprise.
B) not a cost, because they cannot be accurately calculated.
C) not a cost, because they accrue to the entrepreneur.
D) not an economic cost, because they are not necessary to acquire and retain entrepreneurial
ability.
Answer: A
Difficulty: Easy
20. Investment in capital goods involves:

A) increasing present consumption.
B) forgoing present consumption to increase future consumption.
C) consuming at the same rate.
D) consuming today and not worrying about tomorrow.
Answer: A
Difficulty: Easy
Topic: Definition
21. In a perfectly competitive market, any larger than normal returns to transferable capital are
reduced when:
A) the government repeals an excess-profits tax.
B) businesses are able to pay other factors of production less.
C) new firms enter the industry, increasing the supply of the product and lowering product price.
D) old firms leave the industry, decreasing the supply of the product and lowering product price.
E) other factors of production agree to a smaller reward for their contribution to production.
Answer: C
Difficulty: Easy
Topic: Definition
22. Some portion of profit may sometimes be considered a component of costs because it:
A) represents a price-determined cost of production.
B) is a pure economic surplus.
C) results from business usually undertaken by corporations.
D) constitutes a premium for risk taking.
Answer: D
Difficulty: Medium
23. The demand and supply of capital is strongly affected by:

A) consumer tastes.
B) the supply of natural resources.
C) interest rates.
D) the level of real income and output.
E) the supply of labor.
Answer: D
Difficulty: Medium
24. A firm's profits equal:

A) sales minus wages.
B) net worth minus depreciation and factor costs.
C) income minus liabilities corrected for inflation.
D) total revenue minus total cost.
E) total revenue minus total labor cost only.
Answer: D
Difficulty: Easy
Topic: Definition
25. An entrepreneur who collects profits in the short run for a new invention is collecting:
A) the competitive rate of return on capital.
B) temporary monopoly profit.
C) rent on his or her effort.
D) a Ramsey surplus.
E) an illegal monopoly profit.
Answer: B
Difficulty: Hard
26. If an investment returns $600 a year forever and the annual rate of interest is 10%, then its present
value is:
A) $6,000.
B) $3,000.
C) $1,000.
D) $600.
E) some positive number that cannot be determined from the information provided.
Answer: A
Difficulty: Easy
AACSB: Analytic
27. The real interest rate is 2 percent per year. If, at the same time, the interest rate on money is 12
percent per year, then:
A) deflation is affecting this economy.
B) the inflation rate is 6 percent per year.
C) the inflation rate is 10 percent per year.
D) the inflation rate is 2 percent per year.
E) the inflation rate is 12 percent per year.
Answer: C
Difficulty: Easy
AACSB: Analytic
28. Real rates of return on capital have not been generally falling in this century because:
A) legal restrictions on interest have been removed.
B) technological progress has shifted the derived demand for capital out.
C) inflation has risen steadily.
D) capital is not subject to diminishing returns.
E) government policy has been to maintain high interest rates.
Answer: B
Difficulty: Medium
29. Why is capital not considered a primary factor of production?

A) It is produced by the economic system itself.
B) It is not a physical good.
C) It is in fixed supply.
D) It does not exist in all economies.
E) None of the above.
Answer: A
Difficulty: Medium
Topic: Definition
30. In an ideal capital market:

A) competitive market forces set the riskless rate of interest.
B) there is no spread of interest rates for ventures of different riskiness.
C) the rate of interest is zero.
D) the net productivity of capital is constant.
E) competitive market forces set the rent of land.
Answer: A
Difficulty: Easy
Topic: Definition
31. The present discounted value of $100 payable 1 year from now, assuming a market rate of interest
of 10 percent, is:
A) $100.
B) $10.
C) $90.
D) slightly less than $90.
E) slightly more than $90.
Answer: E
Difficulty: Medium
AACSB: Analytic
32. In order to make worthwhile the construction of a bridge with a life of 200 years and an estimated
rate of return equal to 10 percent per year the market rate of interest must be:
A) not over 2 percent.
B) not over 20 percent.
C) 10 percent or less.
D) 10 percent or more.
E) not sufficient information given to answer this question.
Answer: C
Difficulty: Easy
33. If capital has a positive rate of return, then by devoting effort toward the production of capital
goods, future total production will:
A) increase, but not necessarily sufficiently to pay back replacement costs.
B) increase sufficiently to pay back replacement costs, no more, no less.
C) increase sufficiently to pay back replacement costs and yield a return in the form of a
percentage interest per annum.
D) increase sufficiently to pay back replacement costs, yield a return in the form of a percentage
interest per annum, and also compensate those who originally abstained from consumption.
E) do none of the above.
Answer: C
Difficulty: Medium
34. Who was the economist that introduced the “time discounting” and “marginal rate of return over
cost” pillars?
A) Irving Fisher.
B) Adam Smith.
C) Joseph Schumpeter.
D) Milton Friedman.
E) Ben Bernanke.
Answer: A
Difficulty: Easy
Topic: Definition
35. "Normal profits" may properly be included in economic costs because:

A) it is normal for business people to want to make a profit.
B) only monopolies are not normal.
C) they include opportunity and implicit costs.
D) costs always include profit markups.
E) this makes private costs equal social overhead costs.
Answer: C
Difficulty: Medium
36. In allocating scarce resources, the market may sometimes reward entrepreneurs with a less than
normal return. A market economy may therefore be described as a system of:
A) profit.
B) socially necessary profit.
C) normal returns.
D) profit or loss.
E) monopoly profit.
Answer: D
Difficulty: Medium
37. Positive profit premiums in excess of normal profits that must be paid to attract people to risky
activities reflect payment to compensate for:
A) risk aversion.
B) temporary excess losses to innovators.
C) constant marginal utility of income.
D) contrived scarcities.
E) a lack of perfect competition.
Answer: A
Difficulty: Medium
Topic: Definition
38. In a small corporation, the economic cost most likely to be overlooked in the measurement of
profit arises from the failure to:
A) keep ownership and control separate.
B) consider corporate profits taxes as a cost.
C) amortize capital expenditures properly.
D) distinguish between long-term and short-term expenditures.
E) acknowledge the normal return to ownership capital.
Answer: E
Difficulty: Medium
Topic: Experience
39. If inflation and depreciation are equal to zero, a pinball machine which costs $2000 and produces
an annual revenue of $200 has a rate of return of:
A) 10% per year.
B) $200 per year.
C) 20% per year.
D) 0% per year.
E) -10% per year.
Answer: A
Difficulty: Medium
AACSB: Analytic
40. The competitive rate of return on capital can be equal to the interest rate only if you eliminate:
A) monopolies and unions.
B) risk, inflation, and imperfect competition.
C) government intervention.
D) imperfect competition and externalities.
E) externalities.
Answer: B
Difficulty: Medium
True/False Questions
41. When interest rates rise, many asset prices fall.

Answer: True
Difficulty: Easy
Topic: Definition
42. The present value is the dollar value today of a stream of income over time.
Answer: True
Difficulty: Easy
Topic: Definition
43. Capital consists of both tangible and intangible assets.

Answer: True
Difficulty: Easy
Topic: Definition
44. Capital is bought and sold in consumer markets.

Answer: False
Difficulty: Easy
Topic: Definition
45. There is only one kind of interest rate.

Answer: False
Difficulty: Easy
Topic: Definition
46. The rate of return that an investment project can earn determines its place in the line for projects
to be done.
Answer: True
Difficulty: Easy
Topic: Definition
47. A more roundabout method of production is not necessarily preferable to a less roundabout
method of production.
Answer: True
Difficulty: Easy
48. The real interest yield on capital allows for price changes but not for depreciation.
Answer: False
Difficulty: Easy
Topic: Definition
49. An increase in land (or labor) will tend to increase the marginal productivity of capital and thus
the rate of interest in at least the short run.
Answer: True
Difficulty: Medium
50. The demand for capital is derived ultimately from the value of the extra consumption of goods
that additional capital makes possible.
Answer: True
Difficulty: Medium
Topic: Definition
51. The nominal interest rate plus the percentage price rise equals the real interest rate.
Answer: False
Difficulty: Easy
Topic: Definition
52. The rate of return to new capital is that market rate of interest at which it would just pay to invest.
Answer: True
Difficulty: Hard
Topic: Definition
53. Long-run equilibrium in the market for capital is reached at the point where net investment
ceases.
Answer: True
Difficulty: Easy
Topic: Definition
54. The rule for making correct decisions about how to use a capital asset over its life is: for the
same cost, choose that use which will yield the longest life for the asset in question.
Answer: False
Difficulty: Medium
55. Profit statistics ordinarily include dividends paid out as well as undistributed corporate earnings.
Answer: True
Difficulty: Easy
Topic: Definition
56. If a firm earning monopoly profits were sold, then the buyers would view those profits as, in
effect, interest.
Answer: True
Difficulty: Hard
57. If I purchase a 1-year subscription for $30 when the interest rate is 10 percent, rather than a 2-
year subscription for $58, I have made a wise investment.
Answer: True
Difficulty: Medium
AACSB: Analytic
58. If technical change ceased, then the rate of interest would continue to encourage people to
increase their saving.
Answer: False
Difficulty: Medium
59. According to the law of diminishing returns, the lower the capital stock, the higher the rate of
return to capital.
Answer: True
Difficulty: Easy
Topic: Definition
60. U.S. Treasury bonds are generally considered a riskless investment.

Answer: True
Difficulty: Easy
Topic: Definition
61. The theory of capital and interest explains how the supply and demand for capital determines
returns such as real interest rates and profits.
Answer: True
Difficulty: Easy
Topic: Definition
62. The nominal interest rate is the interest rate on money in terms of money.
Answer: True
Difficulty: Easy
Topic: Definition
63. The real interest rate is corrected for inflation and is calculated as the nominal interest rate minus
the rate of inflation.
Answer: True
Difficulty: Easy
Topic: Definition
64. Just as the derived demand for labor is obtained from its marginal product curve, so the demand
for capital goods is derived from its marginal product curve.
Answer: True
Difficulty: Medium
Topic: Definition
65. A capital project has a positive rate of return if the present value of total future receipts resulting
from its use exceeds its original cost.
Answer: True
Difficulty: Medium
66. The long-run equilibrium rate of interest in the capital market can be described as either the one
at which the stock of capital stops increasing or the one at which there is no net saving.
Answer: True
Difficulty: Medium
Topic: Definition
67. Society should consider any investment projects whose rate of return is greater than the rate of
interest.
Answer: True
Difficulty: Easy
68. In a competitive system, profits from innovation represent a transitory income that will later tend
to be competed away.
Answer: True
Difficulty: Medium
69. Much of what is ordinarily called profit is really nothing but interest, rents, and wages under a
different name.
Answer: True
Difficulty: Medium
70. In risky but competitive industries, long-run costs of production do not include a positive profit
premium to compensate for risk aversion.
Answer: False
Difficulty: Medium

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Chapter 15

Capital, Interest, and Profits

Multiple Choice Questions

1. Capital consist of:

2. Which of the following would be considered intangible capital?

4. Capital differs from other resources in that it:

9. If net investment is positive, then:

10. If capital has a computable rate of return, then we say that:

11. The rate of return on investment is:

21. Nominal interest rate is:

16. Real interest rate is:

18. The reward to an entrepreneur, as such, is called by economists:

19. For an economist normal business profits are:

20. Investment in capital goods involves:

23. The demand and supply of capital is strongly affected by:

24. A firm's profits equal:

29. Why is capital not considered a primary factor of production?

30. In an ideal capital market:

35. "Normal profits" may properly be included in economic costs because:

41. When interest rates rise, many asset prices fall.

43. Capital consists of both tangible and intangible assets.

44. Capital is bought and sold in consumer markets.

45. There is only one kind of interest rate.

60. U.S. Treasury bonds are generally considered a riskless investment.

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