Suppose firms expect future output to be lower and future ...

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Suppose firms expect future output to be lower and future interest rates to be lower. Given this information, how will firms alter investment in the current period? Explain.
 
  What will be an ideal response?

Question 2

Data on real and nominal interest rates of one-year U.S. T-Bills show that, over the past twenty years,
 
  A) the nominal rate has always been less than the real rate.
  B) whenever the nominal rate rises, the real rate falls, and vice versa.
  C) the nominal rate has varied, but the real rate has not.
  D) the real rate has varied, but the nominal rate has not.
  E) the real rate has always been less than the nominal rate.

[covalentbond]

Answer to Question 1

The reduction in expected future output will cause firms to revise downwards their expectations of future profits. This, all else fixed, will cause a reduction in the present value of future expected profits and will tend to decrease investment. The reduction in the interest rate, however, will tend to increase investment because it will increase the discounted present value of future expected profits. The effects, therefore, on investment are ambiguous.

Answer to Question 2

E

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Correct answers!

[covalentbond]

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