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
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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?
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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
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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
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R/P is the real rental price of capital (also called the user cost of capital , uc ), and is equal to the (real) interest rate (r) plus the depreciation rate (d): uc = r + d
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This note was uploaded on 02/15/2011 for the course BUAD 350 at USC.

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

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