N41 - Investment - Life cycle theory of consumption -...

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Unformatted text preview: Life cycle theory of consumption - incomes different in - account for consumption Permanent income hypothesis - is key - Ct based on long-term income - does not change with - wealth made up of: o : constant proportion consumed o : does not impact consumption Investment - investment in , not financial, assets - how do firms decide whether to purchase capital? - still based. on o augment with rate, PDV of stream of compare it with the l.estimate o 5 = 2. compute PV of - purchase in period. t: factory built, machine installed - operating in :first “:1 earned - discounted. PV of profits: - account for depreciation in t+2: - putting both together: of expected profit, accounting for l l PV= ‘9 +—(1—5)He +... 1+rr (1+rt)(1+ nil) 3. cost-benefit analysis - is the ? o comparing price of machine measured in terms of (real cost) with the present value of (real benefit) How does this generalize to the overall level of investment in an economy? _ It : - positive relationship between and of - similar to how : recall that dividends come from expectations of firms“ profits Relationship btw investment and the stock market - suppose K = and shares of stock = - price per share = $ , price per machine = $ - what should firms do? - firms: 0 should of stock (each share generate $ ) o invest in (each unit of K costs $ ) - James Tobin: there should be a between stock prices and investment levels does not require calculations of 0 stock prices do the same —> tells firm how much the public - firm’s role: compare price of of capital with public’s willingness to - stock prices is the public’s assessment of the firm’s success 0 high mkt price —> investors willing to invest I firm has 0 high prices also mean I positive relationship btw - to prove validity of this relationship: 0 plotted. (variable ), compared it to o closely matched value of one—unit of K known as - Tobin’s q constructed by: o finding (price of share X number of shares) 0 find the total value of (another form of raising ) 0 add value of stock and value of "bonds: 0 divide by the ( cost) 0 outcome: value of a unit of capital installed relative to its current purchase price - the , the higher the value of capital relative to how much it costs oq>1—) o magnitude of Tobin’s q indicates should occur o from example, Tobin’s q is: = [$ >< ]/$ - interesting note: the data between and match up best when using: 0 — tells you whether or not to invest o — tells us how much was invested 0 supports earlier assumption that investments take time to be built and installed before in the next period - neat, but not altogether surprising: 0 investment decisions and stock prices 0 depend on expected , expected Special Case - intuitive relationship btw , , and - suppose fixed over time - simplifies the earlier expression: - present value of profits is dependent on r (discounting future payments) and 8 (accounts for decreasing K stock) - replacing the previous investment function: ...
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N41 - Investment - Life cycle theory of consumption -...

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