Business Macro Flashcards
Factors impacting on investment
Investment is new spending on capital goods which allows increased output of future goods and services.
Change in the rate of interest. A fall in interest rates increases the amount of autonomous investment in the economy. A rise in interest rates reduces the amount of autonomous investment. There are more profitable investment opportunities at low interest rates, and fewer at high interest rates (see negative gradient of marginal efficiency of capital curve).
Reduction in expected growth. Forecasted lower economic activity than previously expected leads to a fall in investment (as predicted by the Accelerator model – see below).
Decline in banks’ willingness to lend. Fall in investment, since firms have liquidity restraints. Some can use own resources to invest, but many rely on external finance.
Decline in business confidence. Uncertain revenue streams mean it is more likely projects may not yield expected returns. This can be induced by external shocks (e.g. terrorist attacks) or subjective expectations of economic agents (e.g. confidence crises following a bubble). This results in delays or cancellations to capital investment.
Decline in consumer confidence. Rise in uncertainty leads to fall in consumption, hence reducing net demand. Accelerator model predicts this will lead to a fall in investment – see below.
Government investment subsidies. Reduces cost of investment and should increase levels (e.g. R&D spending, renewables). May create inefficiencies as investment is no longer dependent on market forces.
Increase in exchange rate. If higher exchange rates reduce exports, income is reduced and hence autonomous investment reduces for export firms. If there is a subsequent impact on interest rates, the marginal efficiency of capital will have an effect.
Accelerator model of investment
Total capital investment varies directly with rate of change of output.
Net capital investment is the amount by which the required capital stock changes.
If output increases faster, more capital stock is desired, so capital investment increases.
If output increases slower, less capital stock is desired, so capital investment reduces.
Amount of investment depends on size of change in output.
Assumptions:
o Fixed technological conditions.
o Fixed relative labour/capital prices.
o Fixed amount of capital stock needed to produce output.
Limitations:
o Assumptions inaccurate.
Short term changes met by using up stocks and spare capacity.
Firms don’t always react immediately to changes in demand.
Keynesian consumption function model
Disposable income is the main determinant of consumption.
Disposable income is defined as total income minus total taxes, and we assume a linear
consumption curve C = MPC(Y-T).
The marginal propensity to consume MPC is the gradient of the consumption curve; the
change in C due to change in disposable income. Theory assumes this is between 0 and 1.
Average propensity to consume (APC) falls as income rises, since more is saved.
Model implies that
Distribution of income affects total consumption.
Economies may suffer under consumption as they grow.
Governments can increase demand through fiscal policy.
Life cycle consumption or permanent income model
Both models assume that income varies over a consumer’s lifetime, but they aim to smooth their consumption to their long-run average income.
Expectations on future income change current spending patterns.
Savings may be negative (during retirement).
Saving rates are lower when expectations of earnings are higher.
Government cannot easily affect demand through policy – consumers will not react to
temporary changes.
National income and circular flow
National income is the sum of aggregate consumption, investment, government expenditure and net trade (in an open economy).
Not all income is returned to the circular market – there is leakage through savings, taxes, imports.
This must be compensated for by injections investment, government expenditure, exports.
Equilibrium – injections equal related withdrawals (leakage).
Non-equilibrium – budget surpluses or deficits (government expenditure v taxes); trade
surpluses or deficits (imports v exports); positive or negative net capital outflows (savings v investment).
