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Unformatted text preview: m a c r o Investment Topic 6 Topic 6 - Investment Investment slide 1 Learning objectives Learning objectives In this chapter, you will learn: ¡ leading theories to explain each type of investment ¡ why investment is negatively related to the interest rate ¡ things that shift the investment function ¡ why investment rises during booms and falls during recessions Topic 6 Topic 6 - Investment Investment slide 2 Three Types of Investment Three Types of Investment ¡ Business fixed investment : businesses’ spending on equipment and structures for use in production ¡ Residential investment : purchases of new housing units (either by occupants or landlords) ¡ Inventory investment : the value of the change in inventories of finished goods, materials and supplies, and work in progress. Topic 6 Topic 6 - Investment Investment slide 3 Understanding business fixed investment Understanding business fixed investment ¡ The standard model of business fixed investment: the neoclassical model of investment ¡ Shows how investment depends on – MP K – interest rate – tax rules affecting firms Topic 6 Topic 6 - Investment Investment slide 4 Two types of firms Two types of firms For simplicity, assume two types of firms: 1. Production firms rent the capital they use to produce goods and services. 2. Rental firms own capital, rent it out to production firms. In this context, In this context, “investment investment ” is the rental firms is the rental firms ’ spending on new capital goods. spending on new capital goods. Topic 6 Topic 6 - Investment Investment slide 5 The capital rental market The capital rental market ¡ Production firms must decide how much capital to rent. ¡ Recall: Competitive firms rent capital to the point where MP K = R / P . K capital stock real rental price, R / P K capital supply capital demand ( MPK ) equilibrium equilibrium rental rate rental rate Topic 6 Topic 6 - Investment Investment slide 6 Factors that affect the rental price Factors that affect the rental price For the Cobb-Douglas production function, the MP K (and hence equilibrium R / P ) is The equilibrium R / P would increase if: • ↓ K (due, e.g., to earthquake or war) • ↑ L (due, e.g., to pop. growth or immigration) • ↑ A (technological improvement, or deregulation) 1 Y AK L α α − = ( ) α α − = = 1 K R MP A L K P Topic 6 Topic 6 - Investment Investment slide 7 Rental firms Rental firms ’ investment decisions investment decisions Rental firms invest in new capital when the benefit of doing so exceeds the cost. The benefit (per unit capital): R / P , the income that rental firms earn from renting the unit of capital out to production firms. Topic 6 Topic 6 - Investment Investment slide 8 The cost of capital The cost of capital Components of the cost of capital: • interest cost: i × P K , where P K = nominal price of capital • depreciation cost: δ × P K , where δ = rate of depreciation • capital loss: − ∆ P K (A capital gain, ∆...
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This note was uploaded on 11/12/2011 for the course ECON 2003 taught by Professor Macoeconomics2 during the Spring '10 term at University of the West Indies at Mona.
- Spring '10