Question

A small economy starts the year with \(1 million in capital. During the course of the year, gross investment is \)150,000 and depreciation is \(50,000. What is the economy’s capital stock at the end of the year?

a. \)1,150,000

b. \(1,100,000

c. \)1,000,000

d. \(850,000

e. \)800,000

Short answer

Option B, $1,100,000.

Step-by-step solution

Meaning of stock of capital

The stock of capital at the end of a year (K_t ) is the sum of the previous year’s capital stock (K_t-1) and the current year’s net investment.

$K_t=K_{t-1}+NetInvestment$

The net investment is net capital addition or the difference between total or gross investment and the value of depreciated capital.

Net Investment = Gross Invectment - Value of Depriciation

Explanation for choosing option (b)

Given, the previous year capital stock is $1,000,000, gross Investment is $150,000 and depreciation is $50,000. Thus, capital stock at the end will be $1,100,000, as calculated below:

$\$1,000,000+\$150,000-\$50,000=\$1,100,000$