Transcript Investment Chapter: Application on Kuwait.

The Demand Side
II. Investment
Applied Macro Theory Course.
Supervised By: Prof Mohammad Al-Sekka.
Presented By: Halal Alshbaili.
Agenda.

Introduction
Fixed
Investment

Investment in
stocks
Manufacturing & Investment
Investment
and Stocks
Investment
&
Profitability
Profit &
Availability
of Finance
Investment In Housing
 Conclusion
 Application on Kuwait.

I. Introduction.
Investment Expenditure includes spending
on a large variety of assets.
 Investment can be further broken in two:

Plant
Fixed
investment
Machinery
Vehicles
Investment
Raw
Materials
Investment
in stock
Work in
Progress
Finished
goods
I. Introduction.
1. Fixed Investment .

Fixed Investment is gross fixed investment , or
gross domestic fixed capital formation.
I.1ntorduction.
I. Fixed Investment

What is the interest in studying
investment?

Capital stock is the main reason. In order to calculate it,
it is not enough to have the level of gross investment ,
we need also to know how much capital is being lost.
There are two ways to measure this:

Depreciation
• Is the loss of value of the existing capital
stock due to obsolete &so on.
Scrapping
• Is the amount of capital that is scrapped
& withdraw from capital stock.
I. Introduction.
1. Fixed Investment

Gross Capital Stock :
Includes the value of all capital goods that have not been
scrapped.
GK(t) = GK(t-1) + GI(t) – S(t)
GK(t)= the gross capital stock at the end of period (t)
GI(t)= gross investment during period (t)
S(t)= scrapping in period (t)

Net Capital Stock :
Includes the value of all capital goods net of depreciation.
NK(t) = NK(t-1) + GI(t) – D(t)
NK(t)=net capital stock at the end of period (t)
D (t) = Depreciation
1. Introduction.
1.1 Fixed Investment.
Which measure of capital
we use?
Finance
Productive
Capacity
Net
Capital
Stock
Gross
Capital
Stock
I. Introduction.
1. Fixed Investment.
GK(t) = GI(t) – S(t)
NK(t) = GI(t) – D(t)
1. Introduction.
II. Investment in Stock.
It is important to distinguish between changes in the value of
stocks that are result of inflation and the physical change in
stocks.
1. Introduction.
II. Investment in Stock.

The demand of stocks is clearly related to
current level of output.
II. Manufacturing Investment.
1. Investment and Output.

The Theory that can be used to explain the case of
manufacturing investment is the Flexible Accelerator.
The Assumptions:
1) The Capital stock adjustment mechanism:
K   ( K *  K )

K* 
Desired capital stock
K Actual capital stock
  Fraction
2) The Capital–Output ratio (
)
K*  Y
*Putting These two equations together:
k  Y  k
II. Manufacturing Investment.
1. Investment and Output.

The version that is used is the following :
GKt  Yt 1  GKt 1
- By Estimating this equation we get the following :
GK  0.30Yt 1  0.076GKt 1
•If we assume that firms have a desired ratio of stocks to
output, The Flexible Accelerator, could be applied to stock
building, we finally get:
St  0.22Yt  0.36St 1
II. Manufacturing Investment.
1. Investment and Output.

To see how well these equations variations
investment in manufacturing consider the
following figure:
II. Manufacturing Investment.
II. Investment and Profitability.

1.
2.
Investment should be dependent on
profitability for two reasons :
Firms are assumed to maximize profits.
High profits provides an incentive to invest
which is dependent on two factors:
The profits the firms
expect to obtain on
new investment.
The cost of
obtaining finance.
Tobin’s ‘q’
II. Manufacturing Investment.
II. Investment and Profitability.

Estimated the cost of capital ,the rate of return on capital, and the
value of q that result from them are shown at the following:
II. Manufacturing Investment.
III. Profits & the availability of finance

Another method of linking profits to
investment is by arguing that high profits
provide the funds that firms need to finance
investment.

How can this argument make sense?
Only when the capital market becomes imperfect
* Imperfections can be raised in a number of ways:
1) Borrowing and Lending rates may be differ
2) Transaction costs may be associated with borrowing
&lending
II. Manufacturing Investment.
III. Profits & the Availability of Finance.
Tobin’s ‘q’
 Can be defined in two ways:

1) The ratio of the rate of return on capital ( R )
to the cost of capital ( )
q  R / rk
k
r
2) The ratio of the market value of a firm, V, to the value
Of its capital stock at replacement cost .
q  V / PK
PK
II. Manufacturing Investment.
III. Profits & the availability of finance.
These two definitions are equivalent by :
As
R = Pr ofits / PK

•The of cost of capital
rk
Pr ofits / V
• It follows that:
q  R / rk  ( profits / PK ) /(Pr ofits / V )  V / PK
II. Manufacturing Investment.
III. Profits & the Availability of Finance.
The figure clearly shows a correlation between
saving and investment.
III. Investment In Housing.
• It is apparent that Total Investment is
the sum of both the Public and Private
investments.
III. Investment In Housing.

Private–sector can explained by the theory
that the market price depends on supply and
demand for the stock of housing.

The demand : Dependent on several factors
such as household incomes and the cost of
mortgages.

The supply: Dependent on the prices of
housing relative to the cost of building new
housing.
III. Investment In Housing.
•The figure shows that there is close
connection between the real price of
housing and investment on housing.
III. Investment In Housing.
The figure shows the changes in two
variables that make up the real price
of housing.
Conclusion.
Investment is highly dependant on
expectations, giving it an unpredictable
nature.
 Because of this, Investment can be very
hard to explain.
 The Accelerator Model mentioned earlier
has the highest success rate, making
Investment more predictable.

Application
on
Kuwait
Investment Chapter:
Application on Kuwait.
GI ( Gross Investment)= the total capital Formation.
 GI= calculated in Millions Kuwaiti Dinar.
 Data calculated from 1971-2007.

As you can
see that total
is fluctuate with
raising trend
Investment Chapter:
Application on Kuwait.
GDP= gross domestic production .
 GDP is taken from constant price on 2000.
 The data calculated from 1971-2007.

The GDP trend was
highly
fluctuated
pre-Occupation
then it rose sharply
and Steadily
post-Occupation.
Investment Chapter:
Application on Kuwait.
Ratio= GI/ GDP.
From 1971-2007.
•The ratio
Is cut as we
can see
due to Iraqi
occupation.
Investment Chapter:
Application on Kuwait.
Investment
Fixed investment
Gross Capital Stock
Gross Capital Stock :
GK(t) = GK(t-1) + GI(t) – S(t)
Stock investment
Net Capital Stock
1.
GK(t)= the gross capital stock at the end of
period (t)
GI(t)= gross investment during period (t)
S(t)= scrapping in period (t
Thus we can not apply this
formula on the case of
Kuwait economy as the
data of scrapped is not
available.
We can apply this formula as
all the data necessary is available
(more on that later).
Investment Chapter:
Application on Kuwait.
2. Net Capital Stock :

NK :gross fixed capital formation which is calculated in million KD , from
1971-2007
.

NK(t) = NK(t-1) + GI(t) – D(t)

NK(t)=net capital stock at the end of period (t)

D (t) = Depreciation
NK= 0.112lagNk+0.899GI+(-0.09Dep)
Investment Chapter:
Application on Kuwait.
Although there are two variables (lagnk & Dep) are insignificant
The R -square is very high (99%) which allowed the fitted line to be so close
to the actual one, this is obvious can on the figure below.
Investment Chapter:
Application on Kuwait.
k  Y  k
Using the case of manufacturing investment
to explain how the level of aggregate output is clearly
affecting firms investment decisions, this can be done by
a flexible accelerator
K = change in gross capital formation starting from 1971to 2007.
=
is the degree of responsive
= is the capital – output ratio.
Y = is the GDP at constant price on 2000.
 = is the actual gross capital formation starting from 1971-2007.

Investment Chapter:
Application on Kuwait.
•Only one variable is
significant which is
The following is the result of a flexible accelerator.
Actual gross investment
at 5% level of test.
R-square and
Adjusted R-square are
very low as we can
notice from the output.
•Durbin-Watson test
shows that there is
positive autocorrelation.
K  1.27Y  0.199K
From the results shown above , we can obtain the following:
1.  = 0.199
2.

=6.38
Investment Chapter:
Application on Kuwait.

The figure below shown there is highly gap between the actual and
the fitted graph this is due to low R-square=0.52 and adjusted
R-square=0.50
Investment Chapter:
Application on Kuwait.

We can apply the flexible
accelerator formula on the case
of gross capital formation.
GKt  Yt 1  GKt 1

Data from(1971-2007), calculated
in million KD
GK  1.26Yt 1  0.26GKt 1

 =0.26

 =4.84
Investment Chapter:
Application on Kuwait.

The figure shown below represents the high fluctuation for the
actual line than the fitted one, which can be rely on the low
R-square and Adjusted R-square(0.51, 0,49 ).
Investment Chapter:
Application on Kuwait.
According to the data available for Kuwait
The following will be the last equation we
can apply to it.
 S  Yt  S t 1

S
Yt
St 1
= change in capital stock we apply it as change in inventories
from 1971-2007 in million KD.
= in actual GDP at constant prices in 2000
calculated in million KD
= is the lagged capital stock , from 1971-2007
,calculated in million KD
Investment Chapter:
Application on Kuwait.

The output is:
S t  0.77Yt  0.28S t 1
 =0.28
= 2.75
1.
2.

• 0.77= represent that for each
1 KD increase in GDP
The change in capital stock will
Increase by 0.77
• 0.28=represents that for each 1 KD
increase in lagged capital stock
The change in capital stock will
Increase by 0.28
Investment Chapter:
Application on Kuwait.

The figure shown below represents the highly fluctuation for the
actual line than the fitted one, which can be rely on the low
R-square and Adjusted R-square(0.20, 0,18 ).
Thank you
for listening.