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### Investment and Goods Market Equilibrium

Course: ECON 1110, Spring 2008
School: Pittsburgh
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Word Count: 438

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#7 Lecture Investment and Goods Market Equilibrium Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7 1 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...

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#7 Lecture Investment and Goods Market Equilibrium Econ 1110, Spring 2008, Professor Ted Temzelides, Lecture #7 1 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 4 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 6 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 9 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 11 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 12 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 13
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