This problem also uses the example in Table 16-1 and the flexible accelerator from problem 3. Assume

Question:

This problem also uses the example in Table 16-1 and the flexible accelerator from problem 3. Assume that f equals 0.5. Suppose that the desired capital-expected sales ratio v*, depends on the real user u. In particular, v* = 5.5 - 10u
Table 16-1 Workings of the Accelerator Hypothesis of Investment for the Hypothetical Mammoth Electric Company

(a) Suppose that the real interest rate equals 5 percent (0.05) and that the capital stock lasts for 10 years, so that d equals 0.1. Calculate the real user cost of capital and the desired capital stock in periods 1€“5. Explain why the amounts of the capital stock, net investment, and gross investment in periods 1€“5 are the same as in part a of problem 3.
(b) Suppose that in period 1, the real interest rate falls to 3 percent (0.03) and stays at that level for periods 2€“5. Given no change in the depreciation rate, compute the new real user cost of capital, and the new amounts of the desired capital stock, the actual capital stock, net investment, and gross investment in periods 1€“5.
(c) Suppose that the real interest rate equals 5 percent (0.05), but that the capital stock depreciates more quickly, so that d equals 0.2. Calculate the new real user cost of capital, and the new amounts of the desired capital stock, the capital stock, net investment, and gross investment in periods 1€“5.
(d) Use your answers from parts b and c to discuss the effect of changes in the real interest rate and the depreciation rate on the amounts of net and gross investment.
(e) Use your answer to part b to discuss how the flexible accelerator can be used to explain why the economy€™s output responds with a lag to a change in monetary policy.

Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...