Quiz 27: Investment, the Capital Market, and the Wealth of Nations


a) An increase in the positive time preference will influence interest rates in the economy. If lenders lend for longer time periods then the interest rates which they charge will also be high as compared to lending money for shorter durations. Time has a direct impact on interest rates such that if the time period is longer then interest rates charged on that will be high. b) An increase in positive time preference of borrowers will have the same effect as that of lenders i.e. the increase rates would increase. Borrowers would demand money for a longer time period and thus would have to pay higher interest rates to lend from lenders. c) Inflation indicates an increase in the supply of money in an economy which leads to increase in the price and cost of goods. In such a case lenders try to increase their interest rates so as to achieve a better return from the money lent, since an increase in inflation rates increases the time value of money. d) An increase in uncertainty about nuclear war will increase interest rates because a risk of future war would make investors move out of the economy. In order to attract them back, the policymakers will have to increase interest rates in order to increase the returns from their investments. e) If investment opportunity increases in Europe then investors will shift their money and investments from US to Europe. As a result policymakers will have to increase interest rates in the economy in order to increase the returns from their investments and thus attract more investment into the economy.

Capital investment is the investments done in assets which helps in production process and earn capital gains. Business firms use machinery and other capital assets to make production efficient as using these assets reduces the time and money spent to produce goods and services. Firms are able to minimize their costs and thus earn more profits.

Human and physical capital both tries to achieve an efficient level of production. So firms and the managers should try to achieve a balance of these two resources so that they can produce effective output and earn more and more revenue out of that. However, the two of them differ in context of investment. Physical capital needs a large pool of investment where as human capital doesn't require much investment. Moreover, different firms face different demands of both. For e.g. a service firm would require more of human capital while a manufacturing firm would require more of physical capital. Profitability of physical capital investment is determined by the total output which is produced using it. The net profit can be calculated by subtracting the revenue earned from the output produced minus the cost of using the capital. Human capital also generates profits as physical capital cannot be operated in the absence of human capital. A firm needs both types of capital to complete its production process. So, human capital also helps to generate revenue out of the investment made by the firm.

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