sg12 - 12 Investment and Financial Markets Chapter Summary...

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12 Investment and Financial Markets Chapter Summary An investment, broadly defined, is an action that creates a cost today but provides benefits in the future. In this chapter, we broaden the definition of investment to include actions taken by anyone—individuals, firms, and governments—to improve one’s well-being in the future. The chapter discusses theories of investment and how decisions are made to invest or not. Present value is the primary tool you will use to analyze investments. The concept of interest rates and how they relate to investment purchases will be discussed. The chapter closes with a discussion of financial intermediaries and how they facilitate investment. Here are the main points of the chapter: Investments incur costs today but provide benefits in the future. Investment spending is a volatile component of GDP because expectations about the future are uncertain and ever changing. We use the concept of present value to compare the costs and benefits of investments that occur at different points in time. The present value of a payment K , t years in the future, at in interest rate of i is: Present Value (1 ) t K i = + The real interest rate equals the nominal interest rate minus inflation. Investment spending depends inversely on real interest rates. Financial intermediaries reduce the risk and costs of making investments by pooling the funds of savers and monitoring the projects of borrowers. Applying the Concepts After reading this chapter, you should be able to answer these four key questions: 1. How do fluctuations in energy prices affect investment decisions by firms? 2. How can understanding the concept of present value help a lucky lottery winner? 3. Why are there different types of interest rates in the economy? 4. How does the government affect the home mortgage market today?
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174 Chapter 12 0 Caution! Up until now, we have defined the term investment as purchases of real capital. In this chapter, we will expand the investment definition more broadly. For this chapter, investment is an action that costs an individual, firm, or government now but provides benefits in the future. 12.1 An Investment: A Plunge into the Unknown Investment happens in a world of uncertainty. Some investors will react optimistically to this uncertainty. Other investors will react pessimistically. In general, when the future is uncertain, firms become cautious and may postpone making investment decisions such as purchasing additional computers, expanding an office or plant, or creating a new line of products. Figure 12.1 plots total investment spending as a share of U.S. GDP from 1970 to 2005. You need to notice two things about Figure 12.1: 1. From 1970 to 2005, the share of investment as a component of GDP ranged from a low of about 11 percent in 1975 to a high of over 18 percent in 2000—a dramatic 7-percentage-point difference.
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This note was uploaded on 10/25/2009 for the course ECON 81509 taught by Professor during the Spring '09 term at Mesa CC.

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sg12 - 12 Investment and Financial Markets Chapter Summary...

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