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Chapter 10: Q6. (page 215)

Suppose a handbill publisher can buy a new duplicating machine for \(500, and the duplicator has a 1-year life. The machine is expected to contribute \)550 to the year's net revenue. What is the expected rate of return? If the real interest rate at which funds can be borrowed to purchase the machine is 8 percent, will the publisher choose to invest in the machine? Will it invest in the machine if the real interest rate is 9 percent? If it is 11 percent?

Short Answer

Expert verified

The expected rate of return of the duplicating machine is 10%.

The publisher will choose to invest if the borrowing interest rate is 8%.

The publisher will choose to invest at a 9% interest rate.

The publisher will choose not to invest at an 11% interest rate.

Step by step solution

01

Computing the expected rate of return

The cost of duplicating a machine (TC) with 1-year life is 500, and the expected revenue (ER) is 550, which gives the expected rate of return (Err) as:

Err=ER-TCTC=550-500500脳100Err=10%

Thus, the expected rate of return for the investment is 10%.

02

Decision to invest if the interest rate is 8%

The handbill publisher will undertake the investment as long as it is profitable to borrow, that is when the real interest rate is less than the expected rate of return.

An 8% interest rate is lower than the Err, which is 10%; hence, the publisher will undertake this investment.

03

Decision to invest if the interest rate is 9%

A 9% interest rate is lower than the Err, which is 10%; hence, the publisher will undertake this investment.

04

Decision to invest if the interest rate is 11%

An 11% interest rate is higher than the Err, which is 10%; hence, the publisher will not undertake this investment.

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Most popular questions from this chapter

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal?

  1. A large decrease in real estate values, including private homes.
  2. A sharp, sustained increase in stock prices.
  3. A 5-year increase in the minimum age for collecting Social Security benefits.
  4. An economywide expectation that a recession is over and that a robust expansion will occur.
  5. A substantial increase in household borrowing to finance auto purchases.

What will the multiplier be when the MPS is 0, 0.4, 0.6, and 1? What will it be when the MPC is 1, 0.90, 0.67, 0.50, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is 0.80? If the MPC instead is 0.67?

Why is the actual multiplier in the U.S. economy less than the multiplier in this chapter鈥檚 example?

Suppose that the linear equation for consumption in a hypothetical economy is C = 40 + 0.8Y. Also, suppose that income (Y) is $400. Determine

  1. the marginal propensity to consume,

  2. the marginal propensity to save,

  3. the level of consumption,

  4. the average propensity to consume,

  5. the level of saving, and

  6. the average propensity to save.

Refer to the table below.

  1. Fill in the missing numbers in the table.

  2. What is the breakeven level of income in the table? What is the term that economists use for the saving situation shown at the $240 level of income?

  3. For each of the following items, indicate whether the value in the table is either constant or variable as income changes: the MPS, the APC, the MPC, the APS.
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