Transcript Lecture 13
Aggregate Expenditure Model Investment Alomar_111_13 1 Investment Is the second component of private spending (beside C). Investment consists of expenditure on new plants, capital equipment, machinery, inventories… Investment decision: marginal benefit vs. marginal cost Alomar_111_13 2 If expected rate of return > interest rate of borrowing funds: invest If expected rate of return < interest rate of borrowing funds: not to invest Note that investors take their investment decision based on the real interest rate: R=nominal rate – rate of inflation Alomar_111_13 3 Deriving the investment demand curve: What determine the amount of funds that investors borrow? Real interest rate (rr): an increase in rr will increase the cost of borrowing funds, thereby reducing the amount of I. A decline in rr will reduce the cost of borrowing funds, thereby increasing I. Alomar_111_13 4 Investment Demand Curve (ID): rr ID Alomar_111_13 5 Determinants of I: Changes in the level of rr will lead to a move in ID curve. This is the only factor leading to a move along the ID curve. All other factors will shift the ID curve. Alomar_111_13 6 Other determinants of I: 1. Acquisition, maintenance, and operating costs: The initial and then the operating cost of capital affect the expected rate of return in I. 2. Business Taxes: increase in taxes will reduce expected profitability. Alomar_111_13 7 3. Technological changes: stimulates investment and lower production costs. 4. Stock of capital goods: as inventories rise, expected rate of return on investment increase. Alomar_111_13 8 5. Expectations: EX(r) depends on firm’s expectations about sales, future operation costs, future profitability… Alomar_111_13 9 Investment and Real Outputs We now related the level of (I) to the level of real outputs and income. We will assume that we have “planned I” that is independent of the level of DI and real outputs. This is the case since I level is instable. Alomar_111_13 10 Equilibrium GDP: Now we combine both: C and I to explain the equilibrium level of outputs, income, and employment. The following table shows this process: Alomar_111_13 11 Ag. Exp. (C+I) Unp. chg. in inventory $370 $375 $-5 $20 390 390 0 $20 410 405 5 $20 $395 410 425 $-25 -20 -15 increase increase increase 430 420 10 $20 440 -10 increase 450 435 15 $20 455 -5 increase 470 490 510 530 450 465 480 495 20 25 30 35 $20 $20 $20 $20 470 485 500 515 0 +5 +10 +15 Equlm decrease decrease decrease 550 510 40 $20 530 +20 decrease GDP C S I Alomar_111_13 12