Chapter 14 Flashcards
What is the formal definition of investment in macroeconomics? What is capital?
Investment is purchases of new capital, which increase the economy’s productive capacity.
Capital refers to assets such as equipment, structures, and intellectual property.
What are the three types of investment?
- Business investment
- Inventory investment
- Housing investment
True or False: Trading existing assets counts as macroeconomic investment.
False
What is capital stock?
Capital stock is the total quantity of capital at a point in time.
Fill in the blank: Investment is the flow of new purchases of capital that add to _______.
capital stock
What is depreciation?
Depreciation is the decline in capital due to wear and tear, obsolescence, accidental damage, and aging.
What type of investment does business investment refer to?
Business investment refers to the money that businesses spend on new capital assets.
What does inventory investment include?
Inventory investment includes maintaining inventories of raw materials, work-in-progress, and unsold goods.
True or False: The sale of existing homes counts as macroeconomic investment.
False
What are the factors that influence investment?
- Future expectations
- Interest rates
- Lending standards
Define compounding.
Compounding is the accumulation of money over time, as you earn interest on both your principal and accrued interest.
What is the formula for future value after ( t ) years?
Future value = Present value × (1 + r)^t
What does discounting convert?
Discounting converts future values into their equivalent present values using a discount rate.
What is the present value?
Present value is the amount of money that you would need to invest today in order to produce a specific benefit in the future.
What is the discounting formula derived from?
The discounting formula is derived by rearranging the compounding formula.
What is the difference between nominal and real interest rates?
Nominal values refer to the actual number of dollars, while real values adjust for inflation.
What does Compound Annual Growth Rate (CAGR) represent?
CAGR is the annual rate of return at which an investment would have grown if it had grown at the same rate every year.
What is Internal Rate of Return (IRR)?
IRR is the annual rate of return, taking into account the timing of the returns.
What is the formula for calculating the future value of an investment?
Future value after t years = Present value × (1 + r)^t
Fill in the blank: The discount rate should reflect opportunity cost, inflation, and _______.
risk
What are the components of the discount rate?
- Opportunity cost
- Inflation
- Risk
What is discounting?
Used to figure out how much money in the future is worth today.
What is the discount rate (r)?
The interest rate used in discounting, reflecting the rate of return from investing funds in the next best alternative at an equivalent level of risk.
What is the rational rule for investors?
Pursue an investment opportunity if the net present value is positive.
What should you do if the present value of benefits exceeds the present value of costs?
Invest in the project.
How does depreciation affect future revenue?
Future revenue is projected to be less each year due to depreciation.
What is the formula for calculating this year’s revenue based on last year’s revenue?
This year’s revenue = Last year’s revenue × (1 - d).
What is a perpetuity?
A stream of equal and equally spaced out payments occurring indefinitely.
What is an annuity?
A stream of equal and equally spaced out payments occurring for a period of time.
What is the user cost of capital?
The extra cost associated with using one more machine next year, including forgone interest and depreciation.
What is the expected loss due to depreciation?
Expected loss due to depreciation = d × C.
What is the user cost of capital formula?
User cost of capital = (r + d) × C.
What factors affect the discount rate?
Time, inflation, risk.
What happens to investment when real interest rates rise?
Investment declines as the real interest rate rises. Investment line shifts left
What are the four investment shifters?
- Technological advances
- Expectations
- Corporate taxes
- Lending standards and cash reserves
What is the market for loanable funds?
The market for the funds used to buy, rent, or build capital, bringing together savers and investors.
Who are the suppliers in the market for loanable funds?
Savers who want to lend their funds.
Who are the demanders in the market for loanable funds?
Investors who want to borrow funds.
What is the real interest rate?
The price of a loan, representing the amount of principle that must be paid in interest every payment period.
What is the opportunity cost of money?
The annual return if this money would be invested in the project with the next best return with equivalent risk.
Fill in the blank: The rational rule for investors states to invest when the net present value is _______.
positive.
True or False: A higher real interest rate leads to higher investment.
False.
What does an increase in expectations of future revenues lead to?
Increased investment (investment line shifts right).
What effect do high corporate tax rates have on investment?
They reduce the profits you’ll get to keep from any investment, leading to less investment.
What is the user cost of capital for a $4 million wind turbine with a real interest rate of 6% and a depreciation rate of 4%?
$400,000.
What are savers in the context of the loanable funds market?
Savers are the suppliers who supply their funds to businesses that want to borrow them.
Who are investors in the loanable funds market?
Investors are the demanders who demand funds to help finance their investments in new capital.
What is the financial sector?
The financial sector is the marketplace where savers and investors meet, including banks, the bond market, and stock markets.
What does the real interest rate represent?
The real interest rate is the price of a loan, representing the amount of the principal that must be paid in interest every payment period.
Describe the shape of the supply curve for loanable funds.
The supply curve is upward-sloping, indicating that a higher real interest rate raises the benefits of savings.
Describe the shape of the demand curve for loanable funds.
The demand curve is downward-sloping, meaning a higher real interest rate makes fewer investment projects attractive.
What occurs at the equilibrium in the loanable funds market?
Equilibrium occurs where the supply and demand curves cross, determining the equilibrium real interest rate.
What is the neutral real interest rate?
The neutral real interest rate is the interest rate that operates when the economy is producing neither above nor below its potential.
What happens to the supply of loanable funds when saving decreases?
A decrease in saving shifts the supply of loanable funds to the left, leading to a higher real interest rate.
What happens to the supply of loanable funds when saving increases?
An increase in saving shifts the supply of loanable funds to the right, resulting in a lower real interest rate.
What are the three economic actors that can impact the supply of loanable funds?
- Private savers
- The government
- Foreigners
Define personal saving.
Personal saving refers to saving by households of whatever income they don’t spend, pay in taxes, or invest in something other than bonds.
What is a budget surplus?
A budget surplus occurs when government revenues exceed outlays, increasing the supply of loanable funds.
What is a budget deficit?
A budget deficit occurs when the government spends more than it takes in, decreasing the supply of loanable funds.
What is crowding out in the context of government borrowing?
Crowding out is the decline in private spending, particularly investment, that follows from a rise in government borrowing.
How does foreign saving affect the supply of loanable funds?
An increase in foreign saving shifts the supply of loanable funds to the right, pushing down the neutral real interest rate.
What happens to the demand for loanable funds when investment increases?
An increase in investment shifts the demand for loanable funds to the right, leading to a higher real interest rate.
What happens to the demand for loanable funds when investment decreases?
A decrease in investment shifts the demand for loanable funds to the left, resulting in a lower real interest rate.
List some factors that can shift the demand for loanable funds.
- Technological advances
- Expectations
- Corporate tax cuts
- Easier lending standards + larger cash reserves
What is secular stagnation?
Secular stagnation refers to the long-term decrease in the demand for loanable funds due to structural changes in the economy.
What are the key take-aways of the market for loanable funds?
- The market for loanable funds is for funds used to buy, rent, or build capital.
- Supply shifters include changes in personal saving rates, government saving, or foreign saving.
- Demand shifters include technological advances, expectations, corporate taxes, or lending standards and cash reserves.
Fill in the blank: The market for loanable funds is the market for the funds used to _______.
[buy, rent, or build capital]
