Unit 3

Investment

• Money spent or expenditures on:
• New plants (factories)
• Capital equipment (machinery)
• Technology (hardware & software)
• New homes
• Inventories (goods sold by producers)
• Expected Rates of Return
• How does business make investment decisions?
• Cost/Benefit Analysis
• How does business determine the benefits?
• Expected rate of return
• How does business count the cost?
• Interest costs
• How does business determine the amount of investment they undertake?
• Compare expected rate of return to interest cost.
• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest
• Real (r%) vs. Nominal (i%)
• What's the difference/
• Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post facto.
• How do you compute the real interest rate (r%)?
• r% = i% - π%
• What then, determines the cost of investment cost?
• The real interest rate (r%)
• Investment Demand Curve (ID)
• What is the shape of the investment demand curve?
• Downward sloping
• Why?
• When interest rates are high, fewer investments are profitable, when interest rates are low, more investments are profitable.
• Shifts in Investment Demand (ID)
• Cost of Production
• Lower costs shift ID →
• Higher costs shift ID ←
• Business Taxes
• Lower business taxes shift ID →
• Higher business taxes shift ID ←
• Technological Change
• New technology shifts ID →
• Lack of technological change shifts ID ←
• Stock Capital
• If an economy is low on capital, then ID →
• If an economy has much capital, then ID ←
• Expectations
• Positive expectations shift ID →
• Negative expectations shift ID ←