Lecture_Notes_10 - InvestmentandSaving CHAPTER 10 10.2...

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Investment and Saving CHAPTER 10
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10.2 INVESTMENT, SAVING, AND INTEREST Investment Demand Other things remaining the same, The higher the real interest rate, the smaller is the quantity of investment demanded. The lower the real interest rate, the greater is the quantity investment demanded.
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10.2 INVESTMENT, SAVING, AND INTEREST The real interest rate is the opportunity cost of the funds used to finance the purchase of capital. So in making their investment decision, firms compare the real rate of interest with the rate of profit they expect to earn on their new capital. Firms invest only when they expect to earn a rate of profit that exceeds the real interest rate. The higher the real interest rate, the fewer projects that are profitable, so the smaller is the amount of investment demanded.
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10.2 INVESTMENT, SAVING, AND INTEREST Investment Demand Curve: It shows the relationship between the quantity of investment demanded and the real interest rate, other things remaining the same.
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10.2 INVESTMENT, SAVING, AND INTEREST Figure 10.2 shows investment demand. The table and figure show the quantity of investment demanded at five real interest rates. Points A through E on the investment demand curve correspond to the rows in the table.
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10.2 INVESTMENT, SAVING, AND INTEREST Changes in the Investment Demand Curve: When the expected rate of profit changes, investment demand changes. The greater the expected profit from new capital, ceteris paribus, the greater is the amount of investment. This causes the investment demand curve to shift to the right.
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10.2 INVESTMENT, SAVING, AND INTEREST The many influences on expected profit can be placed in three groups: Objective influences, such as, the phase of the business cycle, technological change, and population growth. Subjective influences summarized in the phrase “animal spirits” Contagion effects summarized in the phrase “irrational exuberance”
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10.2 INVESTMENT, SAVING, AND INTEREST The expected rate of profit rises in an expansion and falls in a recession and so brings swings in investment demand over the business cycle. For example, investment soared during the information-based expansion of the late 1990s and sagged during the recession of the early 1990s.
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10.2 INVESTMENT, SAVING, AND INTEREST Technological change lowers costs and creates new and profitable products. But to take advantage of new technologies, firms must invest in the equipment that employs them. For example, to produce a new generation of enormously profitable computer chips, Intel Corporation must invest several billion dollars in chip-making equipment that incorporates the latest technology. Population growth brings a steady increase in the demand for all goods. Greater demand leads to greater profits. But to meet the increased demand and earn the
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10.2 INVESTMENT, SAVING, AND INTEREST “Animal Spirits” Because investment decisions are forward looking, they are based on subjective feelings
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Lecture_Notes_10 - InvestmentandSaving CHAPTER 10 10.2...

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