Download Investment Demand

Investment Demand
The Curve and the Determinants
The Investment Demand Curve
• This curve shows the amount of investment
forthcoming at each real interest rate.
• The main determinants of investment are the
expected rate of return and the real interest rate.
• The marginal-benefit, marginal-cost rule is
applied to determine which investment projects
should be undertaken.
• There is an inverse relationship between the
interest rate (i) and dollar quantity of investment
demanded.
The Investment Demand Curve
Shift vs. Movement Along the Curve
• Generally, any factor that leads businesses to
alter their expected rates of return (r) causes
investment demand to shift.
• If the interest rate changes (i), it is a
movement along the curve.
What Causes ID to Shift?
Acquisition,
Maintenance,
Operating Costs
Business Taxes
Stock of Capital
Goods on Hand
Technological
Change
Future
Expectations
Acquisition, Maintenance and
Operating costs.
• When these costs increase, expected rate of
return from prospective investment
decreases.
• This causes the investment demand curve to
shift to the left.
• When costs fall, expected rate of return from
prospective investment increases.
• This causes the investment demand curve to
shift to the right.
Business Taxes
• An increase in business taxes results in
decreased expected profitability of
investments (r).
• This causes the investment demand curve to
shift to the left.
• A decrease in business taxes results in an
increase of expected profitability.
• This causes the investment demand curve to
shift to the right.
Technological Change
• The development of new products and
improvements in existing products stimulates
investment.
• This causes the investment demand curve to
shift to the right.
Stock of Capital Goods on Hand.
• When firms are overstocked with capital,
there is no incentive to invest.
• This causes investment to decline and the
curve shifts to the left.
• When firms are running low on capital goods
(depreciation), firms tend to increase
investment.
• This shifts the ID curve to the right.
Expectations.
• If businesses expect future sales, future
operating costs, and future profitability to be
poor, ID shifts left.
• If businesses expect more profits in the future,
then they will increase their investment.
• The expected rate of return (r) on capital
investment depends on the firm’s
expectations of the future.
Instability or Variability of Investment
Durability of
Capital
Irregularity
of Innovation
Variability of
Profits
Variability of
Expectations
Test Preparation
• Numbers 1, 3, and 7 on Pages 222 and 223.