# Profits not revenues are taxes so depreciation

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Profits not revenues are taxes so depreciation charges reduce taxes paid because (higher) depreciation charges reduce profits Investment tax credit: a credit for eligible new investments, which reduces tax paid. Desired Capital stock to Investment o Capital stock changes from two opposing channels: Gross investment: changes in new capital which increases the capital stock Depreciation: the amount the capital stock depreciates, which reduces the capital stock. o Net investment = gross investment (I) minus depreciation: K t +1 - K t = I t dK t ,where net investment I t dK t equals the change in the capital stock, K t +1 - K t o I t = K * - K t + dK t Desired net increase in the capital stock over the year K * - K t Investment needed to replace depreciated capital dK t o So the investment function relates investment to its underlying determinants: desired capital and the user cost of capital. As a practical matter, most studies use some output measure (Y) as a proxy for desired capital (K*), so I = F(Y, uc) o Output variable dominates and that the various inputs to user cost affect the timing but not the size of the ultimate investment decision Investment and the Stock Market, Tobins Q o If market value > replacement cost (of physical capital), then firms invest more. o Tobin's q = capital’s market value divided by its replacement cost. If q < 1, don’t invest, since replacement cost > market value of capital If q > 1, invest, since replacement cost < market value of capital
o Market value : stock price times number of (equity) shares, which is the value of the firm’s capital. o Replacement cost: the price of capital times the amount of firm capital. o q = V /( p K K ), where V is stock market value of firm, K is firm’s capital, p K is price of new capital. o How Tobin’s q works: Higher MPK f increases future earnings of the firm, so V rises. Falling real interest rate also raises market value V as people buy stocks instead of bonds. A decrease in the price of capital goods, p K, raises q. Goods Market Equilibrium o Y = C d + I d + G is the goods equilibrium condition . o Note that this differs from the income-identity , as the goods market equilibrium need not hold all the time. Undesired goods may be produced and accumulate as unwanted inventories. So goods market would not be in equilibrium. o Saving investment equilibrium : An alternative representation by subtracting C d + G from both sides of the goods equilibrium condition above: Y - C d G = I d and since national saving S d = Y - C d - G , then S d = I d the saving investment equilibrium. So the goods market is equilibrium when desired saving equals desired investment o The Saving Investment Diagram Relates real interest rates, r, to desired saving and investment: The Saving Curve Shows the relationship between desired national saving and the real interest rate. The upward slope reflects the empirical finding that higher real interest rates raises desired national saving Shifts in the saving curve to the right Increase in current output Fall in expected future output Fall in wealth Fall in government purchases Rise in taxes unless Ricardian equivalence holds, then no effect Crowding out :
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