1. because the cost of adding new capital to old capital increases progressively as the level of investment increases.
2. because the marginal product of capital declines as the stock of capital increases.
3. for both of the above reasons.
4. for neither of the above reasons.
Choose the correct option.
The correct choice is option 1. If there are no adjustment costs of adding new capital to the existing capital stock and new capital goods can be produced at a one-for-one sacrifice of consumer goods, the real interest rate will not decline as the rate at which new capital is being added---that is, the level of investment---increases. It is the adjustment costs that cause the real interest rate to decline in response to increases in investment. The marginal product of capital need not decline as the capital stock increases as long as the new capital is allocated efficiently among the various types---human, physical, knowledge, technology, etc.
Even if the aggregate capital stock is efficiently distributed among the various forms of capital, the marginal product of capital could possibly rise or fall as the capital stock gets larger. But there is no reason why this should necessarily be the case and we assume for convenience of exposition that it is not. The adjustment costs arise because when new capital is added efficiently the quality of the capital stock improves with the increase in the stocks of knowledge and technology and the original capital stock in place must be adapted to work with the capital that is being added. And the capital being added must also be adjusted to operate efficiently with the pre-existing capital in place.