#7 Lecture Investment and Goods Market Equilibrium
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
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User Cost of Capital: An Example
Relevant Information About Machine
Current price of new machine: pK = $100 Price of one-year-old machine next year = $85 Interest rate, r = 8% per year
Cost of Using Machine for One Year
Depreciation: $100 $85 = $15 per unit of capital per year
Depreciation rate, say, d = 15% per year
Interest cost: 8% of $100 = $8 per unit of capital per year Total Cost = $23 per unit of capital per year
General Formula: uc = (r + d)pK
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7 2
The Desired Capital Stock
MPK f and uc
B
MPK f = uc
C uc
A
MPK f
K0
K1*
Capital Stock, K f
3
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
Linking Investment to Desired Capital Stock
It = K* (1 d)Kt Lags and Investment
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
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Effect of Decrease in User Cost of Capital
MPK f and uc
E
uc1
F
uc2 MPK f
K1*
* K2
Capital Stock, K f
5
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
Effect of Increase in
MPK f and uc
f MPK
E
F
uc
MPK f
K1*
* K2
Capital Stock, K f
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Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
Capital Income Taxes
(1 t) MPK f = (r + d)pK
MPK
f
r d pK
1 t
Tax-adjusted user cost:
r d pK
1 t
Effective Tax Rate on Capital
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7 7
Effective Tax Rate on Capital 1990
Country Australia Canada Germany France Italy Japan Sweden UK US Effective Tax Rate 14.6% 25.9% -33.4% 4.6% -72.8% 6.1% 1.0% 28.0% 24.0%
Source: Dale Jorgenson, "Tax Reform and the Cost of Capital: An International Comparison," Tax Notes International, April 19, 1993, Table 1.
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7 8
Goods Market Equilibrium in a Closed Economy
Alternative Forms of Equilibrium Condition
Output = Aggregate Demand for Goods
Y = Cd + Id + G
Desired Saving = Desired Investment
Sd = Y Cd G = Id
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
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Saving-Investment Diagram
Real interest rate, r
Saving curve, S
E
r1
A
B
Investment curve, I
Desired national saving and investment
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7 10
Factors that Shift the Saving Curve
r I F
S2
S1
S=YCG
Decrease in Current Income
E
Increase in Expected Future Income Increase in Wealth
Decrease in Current Taxes
(if Ricardian Equivalence does not hold)
Increase in Government Purchases
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
S, I
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Example: DG = 10
DS = DY DC DG = (DY DT DC) + (DT DG) DS = DSpvt + DSgovt [Note: Assume that TR = INT = 0.]
DG
10
DT
10
DC
4
DS
6 6
DSpvt DSgovt 6
4
0 10
10
0
4
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
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Factors that Shift the Investment Curve
r
I2
I1
S F
Decrease in Effective Tax Rate Increase in Expected Future MPK
E
Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7
S, I
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