Interest Rates & Investment Demand- 02/21/2017

Interest Rates & Investment Demand- 02/21/2017

Investment:
- money spent on expenditures
- ex) new factories, capital equipment, technology, new homes, inventories

How do businesses make investment?
- Expected rates of return
-cost/ benefit analysis

How do businesses determine benefits?
- Expected rate of return
- Interest cost

How do businesses count cost 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, do not invest

-Real- r
-Nominal – i

-Inflation- π

- r% = i% = π%

-Real interest rate determines the cost of an investment decision
- On the investment demand curve, demand will be downward sloping
-When interest rates are high, fewer investments are profitable, when interest rates are low, more investments are profitable

Shifts in ID
-cost of production
-Business taxes
-Technological change

- Stock of Capital
- Expectations

Aggregate Supply
- Level of GDP that firms will produce at each Price Level

Long run vs. Short run
1) Long run:
-period of time where input prices are completely flexible and adjust to change in the price level
-Level of real GDP supplied is independent of price level
-Makes the level of full employment

2) Short run
-Period of time where input prices are sticky and do not adjust to changes in the price level
-Level of real GDP supplied is directly related to price level

Determinants of SRAS:
-input prices
-productivity

-legal institutional environment

Input prices:
-wages (75% of all business costs)
-cost of capital
-raw materials (community prices)

Foreign resource price

-Strong money = lower foreign resource price
-weak money = higher foreign resource prices

Market power
-monopolies and cartels that control resources that control the prices of those resources
-increase in resource prices = SRAS ß
-decrease in resource prices = SRAS à
-Productivity = total output/ total input
-more productivity = lower unit production cost = SRAS à
-lower productivity = higher unit production cost = SRAS ß

Legal institution Environment
-taxes + subsidies
-taxes to government on business increase per unit production cost = SRAS ß
-subsides to business reduces per unit production cost = SRAS à

Government Regulation
-Government regulation creates a cost of compliance = SRAS ß
-Reregulation reduces compliance costs = SRAS à