Chapter 14: Investment Flashcards
what do macroeconomics mean when they refer to investments
refers to spending on capital (physical capital, intellectual property)
does buying shares or land count as investments?
no
what is capital stock
what adds to it, what subtracts from it
total quantity of capital at a point in time
investments add
depreciation subtracts
what are the three types of investments
describe them
business investment: spending by business on new capital assets
inventories: businesses invest my maintaining inventories, increase in inventory is counted as investment
housing: spending on building new houses as well as improvements to existing houses
what are three important facts to remember about investments
investment drives the business cycle
investment changes quickly but capital stock changes slowly
investment is a key driver of long-term prosperity
what are the two tools that can analyse how values change over time?
what do they calculate
compounding: calculate how much money grows over time when you leave it to accumulate interest
discounting: calculate how much future money is worth today by calculating how much you would need to put in today to grow it to that amount in the future
what is compounding formula
future value in t years = present value * (1 + r) ^t
r is the interest rate
what is the discounting formula
present value = future value in t year / (1+r)^t
true or false: you can use the compounding and discounting formulas to figure out how much either the nominals or real value of your money changes through time
if so, how:
true
if evaluating nominal value, use nominal interest rate in either equation
if evaluating real value, use real interest rate in either equation
when should you invest in new capital
invest in new capital if the present value of the benefits exceeds the present value of the costs
when
next years revenue / ( r + d ) > upfront costs
what is the valuation formula and what does it do
it calculates the present value of a stream of income
present value of a stream of payments = next year’s revenue / (r+d)
what is the formula for the user cost of capital?
Usercostofcapital=(r+d)×C
what does the user cost of capital represent
the cost of using an equipment for a year
it is the forgone interest plus deprpreciaion
using the user cost of capital formula, when should you invest in another piece of capital
when
next years revenue > (r+d)×C
true or false: the higher the real interest rate, the lower the present value of future revenues
true. higher interest rates will lead to lower levels of investments
what is the investment line
it illustrates how the quantity of investments rise as the real interest rate falls
it will be downward sloping because high real interest rates = low investments
low real interest rates = high investments
the investment line an be shifted
what 4 key factors can cause the investment line to shift
technological advances: invest more, shift right
expectations: positive, invest more, shift right / negative invest less, shift left
corporate taxes:
high taxes, invest less, shift left / low taxes, invest more, shift right
lending standards and cash reserves:
if banks don’t want to lend, low investment, shift left / If banks are less restrictive, invest more, shift right
in an investment line, a shift in which direction represents what
a shift to the right is an increase in investments
a shift to the left is a decrease in investments
what is the market for loanable funds
it brings together savers who want to lend their funds and investors who want to borrow funds
the market determines the long-run real interest rate and therefore the quantity of investment
it is the relationship of supply and demand between real interest rate and quantity
there can be shifts in the supply of loanable funds
what does a shift in each direction represent
decrease: left
increase: right,
what are the 3 factors that will shift the supply loanable funds
- changes in personal saving rates (any factor that shifts people’s willingness to save)
- The budget surplus/deficit shifts government saving (increase in budget deficit will make gov’t saving more negative, shift left, increase in surplus will mean gov’t has more savings, shift right)
- global shocks shift foreign saving (funding that comes from foreigners lending money to Canadians)
what is crowding out
a decline in private investment due to a larger budget deficient
what are the 4 factors that shift the demand for loanable funds
- technological advances
- expectations
- corporate taxes
- lending standards and cash reserves
recently there has been long term trends that have also led to a decrease in the demand for loanable funds, what are the 3
- population growth is slowing, new workers need less investments
- modern economy is increasingly powered by technology firms which don’t use much capital
- capital equipment becomes cheaper, businesses need fewer funds to meet their needs
true or false: nominal interest rate has no effect on the supply and demand for loanable funds?
true
what does the equilibrium in the market for loanable funds show
it determines the equilibrium real interest rate, it is the real interest rate that applies on average over the long run, aka. neutral real interest rate
nominal interest rate:
real interest rate:
how are they expressed, remember the distinction
nominal is expressed in dollars
real is expressed in purchasing power
what is the internal rate of return (IRR)
the IRR is the interest rate at which the present value of future payments would be exactly equal to the initial investment
you should invest so long as IRR exceeds interest rate
