Download Investment Behavior

Chapter 16
The Economics
of Investment
Behavior
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The Historical Instability of
Investment
• Recall: Gross Domestic Private Investment
(GDPI) includes spending on plant, equipment,
inventories, and housing.
• Historically investment has been more volatile
than consumption spending.
– In the 1973-75 recession, GDPI fell 31%.
– In the subsequent boom, GDPI grew by 46%.
– In the 1981-82 recession, fell 26%.
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The Components of GDPI
• GDPI is divided into two main parts, which also have
subcomponents as follows:
– Fixed Investment
• Residential
• Nonresidential
– Nonresidential Structures
– Producers’ Durable Equipment
– Inventory Change
• The behavior of the three major components of GDPI is
shown in Figure 16-1 and summarized below:
– Residential investment turns early.
– Inventor change exhibits sharp but short-lived swings.
– Fixed nonresidential investment has soared in size.
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Figure 16-1 Real Gross Private
Domestic Investment and its Three
Components, 1960–2007
Source: Bureau of Economic Analysis, NIPA Tables.
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The Accelerator Hypothesis
• The Accelerator Hypothesis states that the level
of net investment depends on the change in
expected output.
• Firms attempt to maintain a fixed ratio of their
stock of capital to their expected sales (Ye).
– Expected sales are assumed to be estimated using
adaptive expectations:
Y  Y  j (Y1  Y )
e
e
1
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e
1
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The Accelerator Hypothesis (cont.)
• The accelerator hypothesis assumes that the desired
stock of capital (K*) is a multiple of expected sales:
K* = v*Ye
• Net investment is the change in the capital stock:
In = ∆K = K – K-1
Assuming that capital is acquired quickly,
In = K* - K*-1  In = v*∆Y*
• When there is an acceleration in business and expected
output increases, net investment is positive.
– If expect output stops increasing, In falls to zero.
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Table 16-1 Workings of the Accelerator
Hypothesis of Investment for the
Hypothetical Mammoth Electric Company
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Figure 16-2 The Behavior of Actual Sales, Expected Sales,
Gross Investment, Net Investment, and Replacement
Investment for the Mammoth Electric Company Described in
Table 16-1
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Investment and Real GDP
• The relationship between I and GDP is the same
as between In and Ye according to the accelerator
hypothesis.
– In the special case where expected sales are always set
exactly equal to last period’s actual sales:
In = v*∆Y-1
• This simplest form of the accelerator theory was invented by
J.M. Clark in 1917.
– According to this theory, investment is inherently
unstable since any temporary change in output could
lead to a significant change in investment spending.
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Assessing the Simple Accelerator
• There are three main problems with the simple
accelerator theory based on historical U.S. data:
– In does not respond instantaneously to changes in
output growth, but rather displays noticeable lags.
– These lags are not uniform in length, not does In
respond to changes in real GDP growth with uniform
speed.
– The In/Y does not have a consistent relationship to real
GDP growth.
• Further, despite the investment boom of the late 1990s, the
overall average level of In/Y was substantially lower than before
1990.
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Figure 16-3 The Relation of the Net Investment
Ratio (In/Y) to the Growth Rate of Real GDP (Y/Y)
in the U.S. Economy, 1960–2007
Source: Bureau of Economic Analysis, NIPA Tables. Details in Appendix C-4.
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The Flexible Accelerator
• The Flexible Accelerator theory of investment loosens
several assumptions of the simple accelerator theory:
– Instead of assuming Ye = Y-1 , the flexible accelerator theory allows
for adaptive expectations.
– The flexible accelerator theory no longer assumes that v* is
constant.
– Capital formation is no longer assumed instantaneous.
• Determinants of gross investment
– The fraction of the gap between K* and last period’s actual capital
that can be closed in a single period.
– The response of Ye to last period’s error in estimating actual output.
– The proportion of the capital stock that is replaced each year.
– The desired ratio of capital to expected output (v*).
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The Neoclassical Theory of
Investment
• In the 1960s, Harvard’s Dale Jorgenson showed
that the user cost of capital could be derived from
neoclassical microeconomic theory.
• An extra unit of capital will be purchased if the
expected Marginal Product of Capital (MPK) is
at greater than or equal to the User Cost of
Capital (u): MPK ≥ u
– MPK is the extra output that a firm can produce by
adding an extra unit of capital.
– u is the cost to the firm of using a piece of capital for
a specified period.
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Policies to Affect u
• The user cost of capital (u) depends on several factors:
–
–
An interest cost is involved in buying a capital good.
Physical deterioration lessens the production ability of every
capital good; in addition some capital goods become obsolete.
•
–
The Depreciation Rate is the annual percentage decline in the
value of a capital good due to physical deterioration and
obsolescence.
The interest and depreciation cost are adjusted by price changes
for capital goods.
• Monetary and fiscal policies that lower the interest rate will
lower u and therefore increase I.
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Figure 16-4 The Effect of a Drop in
the User Cost of Capital (u) on the
Desired Capital-Output Ratio (v *)
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Taxation and Investment
• Fiscal policy can also affect the user cost of capital directly
via taxes:
– A higher tax on firms’ profits will raise the effective user cost of
capital for firms.
– Firms can cut their corporate income tax by deducting the value of
depreciation of plant and equipment, so the government can affect
investment by liberalizing or tightening tax laws.
– During most of the 1962-86 period, a substantial part of investment
in the U.S. was eligible for an investment tax credit.
• Typically the tax credit would allow firms to deduct 10% of the value of
their equipment investment from their corporate income taxes.
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Figure 16-5 Change in Real Investment in
Computers and Peripherals and in the
Computer Deflator, 1988–2007
Source: Bureau of Economic Analysis NIPA Tables. Details in Appendix C-4.
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16-17
International Perspective: The
Level and Variability of Investment
Around the World
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Figure 16-6 Effect on Output and the
Interest Rate of a Shift in the Level of
Investment Relative to the Interest Rate
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16-19
Chapter Equations
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Chapter Equations
Y e  Ye1  j (Y1  Ye1 )
(16.1)
 jY1  (1  j )Ye1
General Form Numerical Example
K *  v*Y e
K *  4.0Y e
(16.2)
I n  K  K  K 1
I n  K  K 1  K *  K *1
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(16.3)
(16.4)
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Chapter Equations
I n  K *  K *1
 v* (Y e  Ye1 )  v*Y e
I n  v*Y1
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(16.5)
(16.6)
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Chapter Equations
I
 j (q  1)  d
K
(16.7)
General Form Numerical Example
MPK  u
MPK  14
(16.8)
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16-23