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  • AP Macroeconomics: Interest Rates & Investment Demand

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    Amanda Brown
    54 vizualizări10 pagini
    This document discusses how interest rates affect investment demand. It explains that businesses determine whether to invest by comparing the expected rate of return to the interest cost - if return is higher than cost, they will invest. The investment demand curve slopes downward, as more investments are profitable when interest rates are low. A change in interest rates causes the level of investment to change along the curve, while other factors like costs, taxes, technology or expectations can shift the entire curve. Instability in investment is a major cause of economic fluctuations.

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    This document discusses how interest rates affect investment demand. It explains that businesses determine whether to invest by comparing the expected rate of return to the interest cost - if return is higher than cost, they will invest. The investment demand curve slopes downward, as more investments are profitable when interest rates are low. A change in interest rates causes the level of investment to change along the curve, while other factors like costs, taxes, technology or expectations can shift the entire curve. Instability in investment is a major cause of economic fluctuations.

    Drepturi de autor:

    Attribution Non-Commercial (BY-NC)
    Descărcați ca PPTX, PDF, TXT sau citiți online pe Scribd
    Indicator pentru conținut neadecvat
    54 vizualizări10 pagini

    AP Macroeconomics: Interest Rates & Investment Demand

    Încărcat de

    Amanda Brown
    This document discusses how interest rates affect investment demand. It explains that businesses determine whether to invest by comparing the expected rate of return to the interest cost - if return is higher than cost, they will invest. The investment demand curve slopes downward, as more investments are profitable when interest rates are low. A change in interest rates causes the level of investment to change along the curve, while other factors like costs, taxes, technology or expectations can shift the entire curve. Instability in investment is a major cause of economic fluctuations.

    Drepturi de autor:

    Attribution Non-Commercial (BY-NC)
    Descărcați ca PPTX, PDF, TXT sau citiți online pe Scribd
    Indicator pentru conținut neadecvat
    din 10

    AP Macroeconomics

    Interest Rates & Investment Demand

    What is Investment?

    Money spent or expenditures on:


    New plants (factories) Capital equipment (machinery) Technology (hardware & software) New Homes Inventories (goods sold by producers)

    Expected Rates of Return


    How does business make investment decisions?
    Cost / Benefit Analysis

    How does business determine the benefits?


    Expected rate of return

    How does business count the cost?


    Interest costs

    How does business determine the amount of investment they undertake?


    Compare expected rate of return to interest cost If expected return > interest cost, then invest If expected return < interest cost, then do not invest

    Real (r%) v. Nominal (i%)


    Whats the difference?
    Nominal is the observable rate of interest. Real subtracts out inflation (%)and is only known ex post facto.

    How do you compute the real interest rate (r%)? r% = i% - % What then, determines the cost of an investment decision?
    The real interest rate (r%)

    What is the shape of the Investment demand curve?

    Investment Demand Curve (ID)


    Downward sloping
    When interest rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable Conversely, there are few investments that yield high rates of return, and many that yield low rates of return

    Why?

    The Investment Demand Curve


    r%
    5%

    Changes in r% cause changes in IG. Factors other than r% may shift the entire ID curve

    3%
    $2 trillion $3 trillion

    ID
    IG

    Cost of Production
    Business Taxes

    Shifts in Investment Demand (ID)

    Lower costs shift ID Higher costs shift ID Lower business taxes shift ID Higher business taxes shift ID

    Technological Change
    New technology shifts ID Lack of technological change shifts ID

    Stock of Capital
    If an economy is low on capital, then ID If an economy has much capital, then ID

    Expectations
    Positive expectations shift ID Negative expectations shift ID

    Shifts in Investment Demand


    r%
    When investment demand shifts, different levels of gross private investment occur even while r% remains constant

    4%

    ID
    $2.5 trillion $3.25 trillion

    ID1
    IG

    Instability of Investment
    Durability
    Capital has a long life-span, therefore once it is built there is no immediate need for further investment

    Irregularity of Innovation
    Innovation does not proceed in a smooth linear fashion, instead there are bursts of innovation followed by periods of relative stability

    Variability of Profits
    Profitability is subject to the forces of competition, cyclical changes in the economy, and human management decisions

    Variability of Expectations
    Political, social and natural phenomenon shape our positive and negative expectations of the future

    Instability of Investment
    Many economists believe that investment instability is the chief cause of the business cycle.

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