An economy begins in steady state with an investment rate of 20 percent, a corporate tax rate of 25 percent, a real interest rate of 2 percent, a depreciation rate of 7 percent, and a price of capital that falls at an annual rate of 2 percent.
a) What is the user cost of capital?
b) Suppose the central bank tightens monetary policy by raising the real interest rate from 2 percent to 4 percent. By how much does the user cost of capital rise?
c) Which of the following answers best describes what happens to the economy if the corporate tax rate is set to zero?
Answer Choices:
<1> The user cost of capital is lower thus the investment rate is lower.
<2> The user cost of capital is lower thus the investment rate is higher.
<3> The user cost of capital is higher thus the investment rate is lower.
<4> The user cost of capital is higher thus the investment rate is highe