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ANSWERS: p. 163 #6, 7, 10
The basic determinants of investment are operating costs, business taxes, technological change,
stock of capital goods, and expectations. As the real interest rate rises, the amount of investment
decreases. This is because firms will only invest if the expected return exceeds the interest rate.
Investment is unstable because of the durability of capital goods, the irregularity of innovation, the
variability of profits, and the variability of expectations. Investment spending can rise in the face of
rising interest rates if one of the determinants (mentioned earlier) pushes the investment curve upward.
If the increase in investment (caused by a change in a determinant) outweighs the decrease in amount
of investment (caused by an increase in real interest rates), there will be an increase in the amount of
The expected rate of return is 10%, so the publisher will invest in the machine. The publisher
makes this choice because the expected rate of return is greater than the 8% real interest rate.
The actual multiplier is less than those in the simple examples because of inflation, taxes, and
imports. If inflation occurs, money will have less real value each time it changes hands. Also, as money
changes hands, it is often taxed (also lowering the multiplier). Lastly, as money changes hands, it can be
used to purchase imported goods, which does not increase real GDP.
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