Interest Rates and Investment Demands

Interest rates & Investment demand

-What is Investment

• money spent or expenditures on:

-New plants ( factories)

-capital equipment (machinery)

-technology (hardware and software)

- new homes

- inventories( goods sold by producers)

-EXPECTED RATES OF RETURNS

• how does business make investment decisions?

~cost and benefit analysis

• how does business determine the benefits?

~ expected rate of return

• how does business count the cost?

~ interest costs

•how does business determine the amount of investment they undertake

~ compare expected rate of return to interest cost

~ if expected return > interest cost, then invest

~ if expected return < interest cost, then do not invest

- real(r%) vs nominal (i%)

• whats the difference

~ nominal is the observable rate of interest. Real subtracts out of inflation (pi%) is only known ex post fact

• how do you compute the real interest rate(r%)?

r%= i% - pi%

• what then , determines the cost of an investment decision?

-the real interest rate (r%)

- INVESTMENT DEMAND CURVE (ID)

• what is the shape of the investment demand curve

~ downward sloping

•why?

~ when interest rates are high, fewer investments are profitable; when interest are low, more investments are profitable

- SHIFTS IN INVESTMENT DEMAND(ID)

-cost of production

• lower cost shift ID->

• higher cost shift ID<-

- business taxes

• lower business taxes shift ID->

• higher business taxes shift ID<-

- Technological change

• new technology shift ID->

• lack of technological change shifts ID <-

-Stocks of capital

• if an economy is low on capita then ID->

• if an economy has much capital then ID<-

-Expectations

•positive expectations shift ID->

•negative expectations shift ID<-

-LONG RUN AS- it is a vertical line on output level that represents the quantity of goods and services a nation can produces over a sustain period using all of its productive resources as efficiently as possible with all of the current technology available to it.

-LRAS- is stable at full employment

-LRAS CURVE- represents a point on a economy production possibility curve

-changes in resources, economic growth, 

-does not change as the price level changes