2.2.3 Investment (I) Quiz: Pearson Edexcel Economics A, Unit 2

The 20 questions

1. Gross investment is best defined as:

   • the purchase of existing shares and financial assets by households
   • spending on new capital goods, including replacement of depreciated capital, in a given period
   • the net addition to the capital stock after depreciation has been subtracted
   • spending on new capital goods only, excluding the replacement of worn-out equipment

2. Net investment is calculated as:

   • gross investment divided by the capital stock
   • consumption minus gross investment
   • gross investment plus depreciation
   • gross investment minus depreciation

3. If gross investment is 200 billion and depreciation is 150 billion, what is net investment?

   • 50 billion
   • 350 billion
   • -50 billion
   • 200 billion

4. A negative net investment figure means that:

   • the capital stock is shrinking because depreciation exceeds gross investment
   • firms have raised their stock of inventories this year, so unsold goods have built up and the capital stock has grown rapidly
   • the economy has no investment at all in the period
   • the government has reduced its spending on capital projects, which lowers the capital stock by the same amount in the year

5. Which influence on investment is most directly linked to the rate of economic growth?

   • A faster growth rate lowers expected sales, so firms cut capacity and delay investment projects until demand begins to recover
   • Growth reduces the need for new equipment as productivity falls, so firms replace fewer machines and build less capacity each year
   • A faster growth rate raises expected sales, making firms more willing to build capacity
   • Growth has no effect on investment, which depends only on the level of taxes paid by firms and their owners each year

6. Keynes's concept of 'animal spirits' refers to:

   • the rate at which businesses reinvest their profits each year into new plant and machinery, which depends on the level of retained earnings
   • the level of spending on animal feed by farming businesses, which Keynes used as an indicator of the health of the rural economy
   • the instinctive behaviour of consumers who buy goods on impulse when they see advertising
   • the emotional and psychological confidence that drives business investment decisions beyond calculated returns

7. A fall in the real interest rate is likely to affect investment by:

   • raising the cost of borrowing, so fewer projects are profitable
   • reducing the cost of borrowing, so more projects become profitable
   • having no effect because investment is financed only from retained profit
   • reducing the expected return on new capital equipment in all cases

8. Which of these is an effect of access to credit on investment?

   • Tighter credit always increases investment because firms must use their own cash
   • Easier credit lowers investment by raising the cost of finance
   • Access to credit has no effect because all investment is government funded
   • Tighter credit conditions can prevent viable firms from financing new projects, reducing investment

9. Which factor is most likely to increase investment by UK firms that export to Europe?

   • a fall in demand for exports, which reduces the need for extra capacity
   • a rise in regulatory costs that makes export production more expensive
   • a fall in business confidence about the outlook for world trade
   • a rise in demand for exports, increasing expected returns on new capacity

10. A government introduces tax allowances for capital equipment. What is the most likely effect on investment?

    • investment increases because the after-tax return on capital rises
    • investment falls because firms must pay more tax on profits
    • investment falls because the cost of capital equipment rises
    • investment is unaffected because tax allowances only affect consumers

11. Which of the following is the most likely reason that investment in the UK is more volatile than consumption?

    • Investment depends only on current income, which changes little, so firms' investment plans stay stable whatever their expectations
    • Investment decisions depend on expectations and borrowing conditions, which can change sharply in response to confidence and interest rates
    • Consumption is fixed by long-term contracts, while investment is not, so households cannot change their spending as quickly as firms
    • Investment is fixed by government regulation each year, so its level is set by policy and does not respond to demand or confidence

12. A firm's investment project costs 1 million and yields a return of 100,000 a year. Ignoring depreciation and risk, what is the approximate rate of return?

    • 100%
    • 0.1%
    • 10%
    • 1%

13. Which statement best evaluates the view that investment is the most important component of AD?

    • Investment has no effect on AD because it is financed by savings alone, so changes in investment spending do not alter total demand at all
    • Investment is volatile and can drive cycles, but consumption is much larger, so the claim is only partly true
    • Investment is always the largest component because firms spend more than households on goods and services across the economy each year
    • Investment is smaller than government spending in every economy in every year, so the claim that investment matters most is clearly false

14. The accelerator effect suggests that investment depends on:

    • the level of government spending, regardless of demand
    • the level of interest rates, regardless of demand
    • the level of consumer savings, regardless of output
    • changes in output or demand rather than the level of output itself

15. Why might a rise in interest rates reduce investment more than consumption?

    • Investment projects are often financed by borrowing and are sensitive to the cost of capital over long periods
    • Investment is financed entirely by government grants that are unaffected by rates
    • Consumption is always financed by long-term loans with fixed interest, so households are insulated from changes in the cost of borrowing
    • Firms never borrow, so interest rates do not affect their investment plans

16. Which of the following best defines replacement investment?

    • spending on securities held for the purpose of resale, which is recorded as investment in financial assets by households and firms
    • spending by government on public sector wages and pensions, which is recorded as government investment in human capital each year
    • spending on new capital to replace equipment that has worn out or become obsolete
    • spending on new capital that adds to the total capital stock, increasing the economy's productive capacity in the year it is installed

17. A firm's investment depends on its expected profit from a project. Which factor would reduce the expected profit?

    • an increase in expected demand for the firm's output, which raises the sales the firm can make from the new capacity
    • a fall in the rate of corporation tax on profits, which raises the after-tax return a firm can keep from the project
    • a rise in the price of the project's key inputs with output prices unchanged
    • a fall in the interest rate on borrowing for the project, which lowers the cost of finance and so reduces the return a firm expects

18. Which is an accurate example of how government regulation can influence investment?

    • Regulation affects investment only when it is removed completely, because partial rules have no effect on the costs or risks firms face
    • Planning rules that delay approval of new factories can deter investment by raising the cost and risk of projects
    • Regulation has no effect because firms ignore rules when deciding to invest, so investment decisions take no account of legal requirements
    • Regulation always increases investment by guaranteeing demand for all firms, so every firm is certain of sales when rules are introduced

19. A firm invests 500,000 in a machine that lasts 5 years with straight-line depreciation and no residual value. What is annual depreciation?

    • 100,000
    • 250,000
    • 500,000
    • 50,000

20. Which combination best explains a fall in investment during a recession?

    • lower expected demand and weaker business confidence reduce the returns firms expect from new capital
    • higher expected demand and lower interest rates reduce firms' willingness to borrow
    • a rise in business confidence and lower costs reduce planned investment
    • a stable outlook and a rise in credit access reduce investment

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