Expectations Part 3 Flashcards

1
Q

Gross Capital Formation

A

Producers’ outlays on additions to the capital assets of the economy + net changes in the level of inventories

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2
Q

Give examples of additions to capital assets?

A
  • New buildings
  • Vehicles
  • Plant and Machinery
  • Infrastructure etc
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3
Q

Why does investment matter?

A
  • Investment is extremely volatile on demand side
  • Investment spending is a primary link through which monetary policy affects the economy
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4
Q

What factors do investment decisions depend on?

A
  • Current sales
  • Current real interest rate
  • Expectations of future rates and sales
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5
Q

How do firms decide whether or not to build new machinery or build new plant?

A
  • If present value of profit exceeds the cost, they invest and vice versa
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6
Q

It

A

investment in period t

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7
Q

π t

A

profit per machine for the economy

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8
Q

V (πt)

A

expected present value of future profit per unit of capital

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9
Q

rt

A

real interest rate in period t

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10
Q

A

rate of depreciation

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11
Q

Describe the investment decision.

A
  • Investment depends positively on current profits and PV of future profits
  • Investment depends negatively on current and expected real interest rates and also depreciation
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12
Q

What determines profit per unit of capital?

A
  • Level of sales
  • Existing capital stock
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13
Q

When should firms invest?

A

When the financial value of a unit of their capital exceeds the cost of an additional unit of capital - q > 1

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14
Q

Tobin’s q

A

q = financial value of firm / replacement cost of installed capital

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15
Q

What is the financial value of a firm?

A

Stock market value - dependent on current and expected future profits

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16
Q

What is replacement cost of installed capital?

A

Actual cost to replace the firm’s existing capital goods at the item the stock was issued

17
Q

How does Tobin’s q describe how pessimism about future probability caused negative demand?

A
  • Stock prices fall due to pessimsm
  • Value of firm falls
  • q falls
  • investment decreases