Exam 2 Flashcards
Investment
Purchases of new capital increase the economy’s productive capacity
capital
assets such as equipment, structures, and intellectual property that are used repeatedly to produce output
capital stock
The total quantity of capital at a point in time
Investment types
Business investment: The money that businesses spend on new capital assets
Housing investment: When you invest in building new houses or apartments
Inventories: Businesses maintain inventories of raw materials, work-in-progress, and unsold goods.
Investment as a key economic variable
Investment drives the business cycle
Investment changes quickly, but the capital changes slowly
Investment is a key driver of long term prosperity
Compounding
helps you calculate how much money grows over time when you leave it to accumulate interest
Future Value in one year =
Present value*(1 + r)
Future Value in t years =
Present value*(1+r)^t
Discounting
The money that you’ll receive in the future value in today’s money
Present value =
(Future value in t years)/(1+r)^t
real interest rate =
nominal interest rate - inflation rate
Present value of a stream of payments =
Next year’s profit / (r + d)
The rational rule for investors
(Next year’s profit)/(r + d) > C (up front cost)
User cost of capital =
(r + d) * C
As the real interest rate rises
Investment will decline.
Move up and down the investment line
