Investment rates and demand

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  • Investment is money spent or expenditures on:
    • New plants (factories)
    • Capital equipment (machinery)
    • Technology (hardware & software)
    • New homes
    • Inventories (goods sold by producers)

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Expected Rates of Return
  • How does business make investment decisions? Cost/Benefits 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%) vs. Nominal (i%)
  • What's the difference? 
    • Nominal is the observable rate of interest. Real subtracts out inflation (𝜋%) and is only known ex post factor.
  • How do you compute the real interest rate?
    • r% = i% - 𝜋%
  • What then, determines the cost of an investment decision?
    • The real interest rate r%
Investment Demand Curve (ID)
  • What is the shape of the investment demand curve? Downward sloping
  • This occurs because:
    • 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.

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