Transcript Business Investment

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10.ppt
Business Investment
Lecture 10
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Business Investment
 “Investment”:
not “financial” in the
everyday sense but purchases of plant &
equipment, (or additions to inventories)
 “I” is demand today, supply tomorrow;
unique among GNP spending categories
 The capacity created by I is flexible
(through variation in shifts, maintenance
schedules, etc) so purchase can be
delayed in tough times
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Business Investment
20%
15%
10%
5%
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0%
-5%
-10%
Investment Growth
Real GDP Growth
A key question for
economists seeking
to understand the
business cycle was:
“Why are the cycles
in investment growth
so much greater than
those in output
growth?”
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Gross & Net Investment
I
is “gross investment”
 I-CCA is “net investment”
 a capital stock rises from period to period by
the amount of net investment
 or I(gross)=I(replacement)+I(net)
 K (Capital this period)=
= K\1 + I (gross) - D = K\1 + I (net)
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The Optimal Level of Capital

Simple World: It takes
· one $2500 machine
· housed in a $2500 building
· plus $3000 of labor
· to make $5000 of output.
· Machines last 10 years, buildings 25,
decaying linearly.
· No substitution is possible.
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The Optimal Level of Capital
K
/ Y = ($2500+$2500) / $5000 = 1
 Thus Optimal=Necessary K = 1 x Y
 If Y is constant at $5000, then so must be K
 K decays/depreciates each year by
· 10% x $2500 (equip)=$250
· 4% x $2500 (building)=$100
· thus I (replacement) must be $350 per year to
keep K stable at $5000, with $2500 of each type
of K
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The Optimal Level of Capital
What if the producer wants to boost output (Y)
by 3% to $5150?
 K must rise to $5150, meaning
 I (net) must be $150
 added to I(replacement) $350
 implies I(gross) = $500
 So investment in that year is 10% of output
 In fact, these are the numbers for the US

Machines & Factories Required to Produce Output
12000
10000
6000
4000
2000
Real GDP
Private Cap
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$ Billion
8000
Accelerator Data: Change in Output vs
Levels of Gross & Net Investment
$1,600
$1,400
Recent shift to
even higher
investment
relative to GDP
is due to new
technology
opportunities
$1,200
$1,000
$800
Note: Net Investment
roughly matches the
US change in GDP
$600
$400
$200
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$-
$(200)
Change in Real GDP
Gross Investment
Net Investment
Accelerator Model Implications
for the Business Cycle
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Note how variations in Y get amplified in
variations in I
 A $150 change in Y required a $150 change in I
 Or, a 3% change in Y required a 40+% change
in I
 Realistically, the response to an output change
isn’t so sudden, and the base level of
investment includes some net addition because
output is trending up

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The Optimal Level of Capital
I
= I(gross)= I (replacement) + I(net)
• I (replacement)=dep. rate x K = c1 x K=c1 x Y
• I (net) = c2 * [ Y - Y \1]
I
= c1 * Y + c2 * [ Y - Y\1 ]
 Note
that the level of investment is a function of the
change (the first derivative) in output;
 By extension, the growth of investment (the first
derivative) is a function of the acceleration (the
second derivative) in output:
 Hence
the Accelerator Model of Investment
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The Optimal Level of Capital
 In
a more realistic model, production can temporarily
rise without adding K by adding a shift or overtime or
delaying maintenance, thus c1 is not rigidly fixed, and
new capital- or labor saving technology can be
introduced so c2 is also not rigidly fixed
 The microeconomic basis of c2: the optimal capitaloutput ratio
• relative prices and productivity for capital , output,
and labor determine this
• the first basic extension is the Cobb-Douglas
production model
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The Optimal Level of Capital
Y= KbL(1-b)
 dY/dK=marginal product of capital
 = bK(b-1)L(1-b)

» =b (1/K) KbL(b-1)
» =b (1/K) Y
» =b Y/K = b * Average Product of Capital

marginal product of capital =
b * average product of capital
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The Optimal Level of Capital




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
dY/dK=marginal product of capital
= b * Y/K = b * Avg. Product of Capital
The real price paid per unit of capital is Pk / Py
In equilibrium, this price is its marginal product
• Thus Pk/Py = b * Y /K
Solve for K to find the optimal K:
• K = b * Py/Pk * Y
Or the optimal K/Y ratio = b* Py/Pk
• Just like the simple fixed coefficient model, except
the ratio is now sensitive to the real price of capital
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The Optimal Level of Capital
The price paid per unit of capital is Pk / Py
 In equilibrium, this price is its marginal
product
 Pk/Py = b * Y /K
 What is b, that is how can it be interpreted
beyond “the exponent of capital”?

• b= (Pk * K) / (Py * Y)
• = capital income / total income
• hence the capital share of income
The “Price or Cost” of Capital
 The
cost of funds (“r”)...
 ...minus price appreciation of the real
asset (“inflation”)...
 ...plus the cost of perfect maintenance =
the rate of depreciation (“d”)
 So
the cost, Pk/Py = r - inflation + d
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Transitions between Targeted
Equilibrium Points
 In
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practice, future K (K*) is targeted to hit
the optimal level consistent with an expected
future path of Y (Y*) given an expected cost
of capital ( (Pk/Py)* )
 K* = b Q* (Py/Pk)*
 Economists add lag structures to reflect
expectations
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Examples from a specific company
 The
company manufactures equipment used
to facilitate construction:
» Aerial work platforms (“AWP” in next slides for lifting
people ; 2 types--”scissor lifts” and “boom lifts”
» Material Handlers to lift bricks, wood, etc
 The
“output” driving the need for capital is
thus construction spending
 You will see that the cycle in this firm’s
equipment sales are far greater than the
cycle in construction
 Construction is itself more volatile than GDP
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Historical Patterns in Aerial Work Platform Demand
Growth and Volatility of Industry Sales
AWP Sales Growth
15,000
21,000
10,000
14,000
5,000
7,000
Total Booms
Straight Booms
Scissors
Total Units
•
•
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
0
1985
0
Articulated Booms
The boom and scissors markets are locked in
tandem, with scissors remaining near 70%.
(Total aerial work platform units are charted
against the right scale, scissors and all others
against the left scale)
Articulated booms enjoy a persistent, stable
market preference versus straight booms
0%
-20%
-40%
-60%
-80%
Total Booms
Scissors
Straight Booms
Total Units
1999
28,000
1998
20,000
20%
1997
35,000
1996
25,000
40%
1995
42,000
1994
30,000
1993
49,000
1992
35,000
60%
1991
56,000
1990
40,000
80%
1989
63,000
1988
45,000
100%
1985
70,000
Year Over Year Growth Rate
50,000
Total Number of Units
Number of Units by Product Line
AWP Unit Sales
Articulated Booms
 The cyclical volatility of scissors is similar to that of
total booms, but slightly greater
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Historical Patterns in Aerial Work Platform Demand
Growth Rates in Sales and Served Markets
Unit Growth vs. National Indicators
Nonresidential Construction
Industrial Production (excluding computers)
Gross Domestic Product
Total Units
80%
75%
60%
•
•
One of the primary served markets, nonresidential
construction, is 3-4 times more volatile than the total
US economy, as measured by either manufacturing
production or GDP
Offsetting this liability is the persistently stronger
growth of the aerial work platform industry. Unit
growth is charted against the right scale, 3 times the
left scale used for the national indicators
-20%
Aerial Work Platforms
Value of Semiconductor Shipments
Sales of Electronics
Sales of Semiconductors - Worldwide
-40%
 Perhaps the growth of this sector is best appreciated
by comparing it to a widely-hailed, high-growth, and
high-tech sector: semiconductors
 Three alternate government indicators of
semiconductor growth are charted above; none have
grown as rapidly as aerial work platforms
1999
1998
-60%
1997
1999
1998
1997
1996
1995
1994
-60%
1993
-20%
1992
-45%
1991
-15%
1990
-30%
1989
-10%
1988
-15%
1985
-5%
0%
1996
0%
1995
0%
1994
15%
1993
5%
20%
1992
30%
1991
10%
40%
1990
45%
1989
15%
1988
60%
Unit Growth Rate
20%
Year over Year Growth Rate
25%
National Indicator Growth Rate
Industry Growth Rates
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Historical Patterns in Aerial Work Platform Demand
Cyclical Forces Driving Sales around the Rising Penetration Trend
•
•
•
•
Durable equipment sales are inherently the most cyclical markets in an economy
New equipment purchases serve two goals
» Replace worn-out or obsolete equipment to maintain existing total production capacity.
In your markets, production capacity is required to match construction activity or
manufacturing / commercial operations
 Replacement demands are relatively steady, tending to approximate a percentage of
the pre-existing fleet of equipment accumulated over a decade
 However, even replacement budgets are cyclical, becoming more generous in
prosperous markets and lean in soft markets
» Expand capacity to meet higher production levels
 These are highly cyclic sales, in that if construction is simply flat, no new equipment
is required for expansion
 In other words, the level of such sales tracks the growth in customer production
Equipment sales lag served markets by approximately a year, reflecting two factors:
» Businesses typically extrapolate from recent experience, expecting strong markets to
continue and weak to stay soft, rather than making independent forecasts
» Capital budgets are created at the beginning of a year, then executed through the year
This lag tends to produce cycles of excess or insufficient capacity, producing volatile orders
to the equipment supplier
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Historical Patterns in Aerial Work Platform Demand
A simple model of equipment sales in your industry, using construction as an example:
The customer’s desired fleet is proportional to nonresidential construction: one AWP per $2million of construction
Fleet = 2000 x Construction
Stable construction growth
produces matching equipment
growth
10% of the fleet must be replaced every year.
Replacement Sales = 10% x Fleet (prior year)
thus = 10% x 2000 x Construction (prior year)
Additional Capacity-Expanding Sales match Changes in Construction
Expansion Sales = 2000 x (Construction-Construction (prior year))
Cycle in construction growth
produces amplified equipment
cycle
Total Sales = Replacement + Expansion Sales
= 200 x Construction + 2000 x (Construction-Construction (prior year))
Simplified Example to Highlight Source of Volatility
Year
1
2
3
4
5
6
7
8
9
10
Construction ($ Billion)
$ Billion(Excluding Inflation)
Growth Rate
Construction Equipment
(units)
Existing Fleet
New Sales to meet 2 goals:
Replacement
Capacity Expansion
Total
Growth Rate
100
5%
Requirements
2000 x
Construction
10%
2000 x
Construction
Increase
$
105 $
110 $
121 $
133 $
133 $
127 $
127 $
133 $
140
5%
5%
10%
10%
0%
-5%
0%
5%
5%
200,000
210,000
220,500
242,550
266,805
266,805
253,465
253,465
266,138
279,445
19,048
20,000
21,000
22,050
24,255
26,681
26,681
25,346
25,346
26,614
9,524
28,571
10,000
30,000
5%
10,500
31,500
5%
22,050
44,100
40%
24,255
48,510
10%
26,681
-45%
(13,340)
13,340
-50%
25,346
90%
12,673
38,020
50%
13,307
39,921
5%
Your actual industry cycles, although large, are muted by the year-to-year inertia in customer capital budgeting decisions
and by he ongoing rising penetration of such equipment in construction and manufacturing.
As in this example, cycles in the fleet of units parallel cycles in the served construction market (as shown earlier).
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Historical Patterns in Aerial Work Platform Demand
Cyclical Forces Driving Sales around the Rising Penetration Trend
 Using your trade association data from 1985 through 1999, models reflecting this structure have been estimated for scissor and total boom sales
 Additional factors are the trend gains in penetration in served markets and the potential sales gain in 1999 due to consolidation of the rental industry
 With regard to lags in response, sales are driven by the level and change in construction spending in the current and prior two years
 The estimates confirm a far greater sensitivity of lifts to manufacturing activity; boom sales are almost totally driven by nonresidential construction
Results in models without allowance for special 1999 gain
Booms
Scissors
45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
-5,000
-10,000
% explained (R-squared) =98.3%
Standard error = 847 Units
% explained (R-squared) =97.4%
Standard error = 2858 Units
Potential Rental Consolidation Shift:
1999 Actual - Estimate = 780 Units
Potential Rental Consolidation Shift:
1999 Actual - Estimate = 3307 Units
1999
1998
1997
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
-2,000
1996
0
1995
2,000
1994
4,000
1993
6,000
1992
8,000
1991
10,000
Unexplained Deviations
1990
Unexplained Deviations
1989
12,000
Fitted (without special 99 allowance)
1988
Fitted (without special 1999 allowance)
1987
14,000
Hisorical
1986
Historical
16,000
1985
18,000