First, briefly explain what the user cost or rental cost of ...

[ETearle]

First, briefly explain what the user cost or rental cost of capital represents. Second, explain what factors would cause an increase in the user cost or rental cost of capital.
 
  What will be an ideal response?

Question 2

Suppose that the nominal interest rate increases while the expected inflation rate rises. Given this information, we know with certainty that the real interest rate
 
  A) will not change.
  B) will fall.
  C) will fall, but only if the increase in the nominal rate is smaller than the increase in expected inflation.
  D) will fall, but only if the increase in the nominal rate is greater than the increase in expected inflation.
  E) none of the above

[janeli]

Answer to Question 1

The user cost of capital is the sum of the real rate and rate of depreciation. If a rental agency rented capital, it would have to charge enough to cover any depreciation that occurs plus an amount equal to what it could get if it simply bought bonds (the real rate). Therefore, either an increase in the real interest rate or an increase in depreciation will cause an increase in the user cost of capital.

Answer to Question 2

C