Unit 3- Investment Demand

Unit 3- Investment Demand

What is Investment?

• money spent on expenditures on...

- new plants (factories)

- capital equipment (machinery)

- technology (hardware and software)

- new homes 

- inventories (goods sold by producers)

Expected rate of returns 

• how does businesses make investment decision? 

Answer: cost and benefit analysis

• how does business determine the benefit?

Answer: expect rate of return (outflows, inflows)

• how does business count the cost?

Answer: interest cost

• how does business determine the amount of investment they undertake?

Answer: compare expected rate of truth to interest cost

• if expected return > interest cost, then you'll invest 

• if expected return < interest cost, the do not invest 

Real (r%) v. Nominal (i%) 

- what is the difference? 

• nominal is the observable rate of interest. ( real subtract out inflation (n%) and is only known. (example: post facto)

How do you compute the real interest rate? 

• r% = i% = pi%

Why then determines the cost an investment decision 

- interest cost minus the real inherit rate (r%)  

What is the share of investment demand curve?

-downward sloping 

Why??

• when interest rates are high, fewer investment are profitable. When interest rates are low, more investments are profitable.

Shifts in Investment Demand (ID)

• lower cost shift ID ->

• higher cost shift ID <-

Business Taxes

• lower business taxes shift ID ->

• higher business taxes shift ID <-

Technological of Change

• new technology shifts ID ->

• lack of technological change shift ID <-

Stock of Capital 

- if an economy is low on capital then ID   ->

- if an economy has much capital then ID <-

Expectation 

- positive expectation shift ID ->

- negative expectation shift ID <-

Classical Range v. Keynesian Range

Classical

• competition is good

• the invisible hand (the market will fix itself no government intervention)

Long-run

-- Economy will balance at full employment!!

• trickle down effect ( help the rich first and the everyone else second )

• economy is always close to or at full employment 

Keynesian

• competition is flawed 

• AD is the key not AS

• leaks and savings cause recession 

• ratchet effect & sticky wages block Say's law

• in the long-run we are all DEAD! 💀