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Topic 05 - Investment

# Topic 05 - Investment - BUAD 350 Topic 05 Investment...

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BUAD 350 Topic 05 – Investment

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Keywords Cost of capital Investment Goods Market Equilibrium
Why is Investment Important? Investment fluctuates sharply over the business cycle, so we need to understand investment to understand the business cycle Investment plays a crucial role in economic growth

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Review: Firms Optimal Decisions Assumptions: 1. Assume the typical firm that produces the economy’s output is competitive . It takes price of its output (P) and price of inputs --wage rate (W) and rental rate of capital (R)-- as given. Firm’s actions do not affect prices. 1. Firms maximize profits (= revenue – costs): Π = PY – WL – RK = P F(K,L) – WL – RK How firms choose K and L to maximize Π?
Review: Firms Optimal Decisions Question: How much labor does firm hire ? Profit = Revenue – Cost = (P x MPL) – W If MPL > W/P, firm can profits by L If MPL < W/P, firm can profits by L Optimal L: Hire labor up to where MPL = W/P

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Review: Firms Optimal Decisions w = W/P is the real wage (measured in units of output as opposed to \$) The MPL schedule is the firm’s labor demand curve MPL is decreasing in L, thus the labor demand curve is downward sloping
Figure 3.5 The determination of labor demand

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Review: Firms Optimal Decisions Question: How much capital does firm invest ? Profit = Revenue – Cost = (P x MPK) – R If MPK > R/P, firm can profits by K If MPK < R/P, firm can profits by K Optimal K: Invest capital up to where MPK = R/P
Review: Firms Optimal Decisions R/P is the real rental price of capital (also called the user cost of capital , uc ), and is equal to the (real)

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Topic 05 - Investment - BUAD 350 Topic 05 Investment...

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