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slides_on_investment

slides_on_investment - Intermediate Macroeconomics...

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Intermediate Macroeconomics Investment Theory Cyntia Azevedo November, 26th, 2007 Intermediate Macro (Xavier Sala-i-Martin) () Investment Theory 11/26 1 / 27
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Overview of the class Quick review of previous class (Investment Theory) Some empirical facts about investment Aggregate demand Temporary technology shocks Permanent technology shocks Intermediate Macro (Xavier Sala-i-Martin) () Investment Theory 11/26 2 / 27
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Quick review of previous class Investment demand So far, we were assuming that the only source of demand was consumption Y d = C d which means that we were shutting down G , I and NX . Last class we reintroduced investment demand in the goods market: Y d = C d + I d What does the data say? Investment is the most volatile component of demand Consumption is mostly smooth over recessions and booms Business cycle °uctuations mainly due to ±rms not consumers Intermediate Macro (Xavier Sala-i-Martin) () Investment Theory 11/26 3 / 27
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Quick review of previous class Investment demand Investment is the purchase of goods by ±rms to be used as inputs in the production process of other goods Why do ±rms invest? To increase the number of machines (net investment): K d t ° K t ° 1 To replace depreciated machines: δ K t ° 1 I d t = K d t ° K t ° 1 + δ K t ° 1 = K d t ° ( 1 ° δ ) K t ° 1 K d t : Desired level of capital Intermediate Macro (Xavier Sala-i-Martin) () Investment Theory 11/26 4 / 27
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Quick review of previous class Investment demand TIME TO BUILD : A very important assumption is that investment made today will only be available next period. This implies that ±rms²decisions are based on expected future conditions, not the current state of the world. Y t = A t F ( L t , K t ° 1 ) Firms have a forward looking behavior. The desired level of capital chosen today will only be productive next period. Y t + 1 = A t + 1 F ( L t + 1 , K t ) Intermediate Macro (Xavier Sala-i-Martin) () Investment Theory 11/26 5 / 27
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Quick review of previous class Desired capital stock In order to chose the desired level of capital ±rms balance between the costs and bene±ts of purchasing capital. We saw that if the ±rm borrows to purchase the new capital or uses its own funds for investment, it will face the same decision: Today (time t ) Tomorrow (time t + 1 ) Borrow $ P t ) Payback $ P t ( 1 + R ) + Buy 1 machine ) MPK t + 1 + ( 1 ° δ ) = A t + 1 F K + ( 1 ° δ ) P t + 1 [ MPK t + 1 + ( 1 ° δ )] > P t ( 1 + R ) ) Invest P t + 1 [ MPK t + 1 + ( 1 ° δ )] < P t ( 1 + R ) ) Do not invest Intermediate Macro (Xavier Sala-i-Martin) () Investment Theory 11/26 6 / 27
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Quick review of previous class Desired capital stock Rewritte as ° A t + 1 F K + ( 1 ° δ ) ± > P t P t + 1 ( 1 + R ) = ( 1 + R ) 1 + π = 1 + r A t + 1 F K > r + δ ) Invest A t + 1 F K < r + δ ) Do not invest Real bene±t of buying the machine today is MPK t + 1 Real costs: ² Financial cost ( r ) Physical cost ( δ ) Intermediate Macro
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