Investment Flashcards
Business fix investment assumes
capital value is fixed eg: value of chairs constant
3 factors that influence Investment
- Mariginal Product of Capital [MPK] (photocopier eg)
- Interest Rate
- Tax rules affecting firms
what 2 types of firms assumed
Production & rental
Equation for change in Profit = ___ =____
Show rearranged equation at Max. profit
dProfit = dRev - dcost = P * MPK - R
(additional cost of 1 more unit)
MPK = R/P [at max: profit = 0]
R = Rent
3 factors that affect rental price?
What function do you use?
and What do you do to find MPK?
Capital k, (Earthquake/war)
Labour L, (pop growth/immigration)
Output A, (tech improvement/deregulation)
Cobb Douglas
FOC - change in variables affect rental price
x3 components of Cost of Capital? [real/nominal]
Acronym
COC = DIC
Deprication Cost: Delta X Pk [delta=depreciation rate]
[real] Interest Costs: i X Pk [opp cost]
Capital Loss: negative change in Pk [if +change subtract]
Sum these for Nominal total
Equation for nominal COC
back sheet 2
Profit Rate Equation =
R/P - [Pk/p]*(d + r)
MPK - Rental Costs
If Profit Rate >0
<0
it is profitable to invest more in Capital k
firm reduces capital stock (not replacing)
Net Investment equation = __ = ______________
Gross Investment equation =
sheet 3
affect on Investment of increase in r
how is this shown graphically?
raises COC, reduces profit rate, lowers investment
movement along investment function (towards origin)
affect of ^MPK on investment {graphical}
Investment function shifts outwards/right (^profit rate, ^investment for given r)
2 most important policies affecting investment?
Acronym
Corporate Income Tax
Investment tax credit
CIT is a tax on..
If Pk rises over time….
a firm’s profits
the legal definition understates true cost and overstates profit - taxed more
ITC reduces firm’s ____ for each pound it spends on ___
Effectively reduces ____ which increases ___ ___ so ____rises
taxes, capital
Pk, profit rate, investment
Problems with Neoclassical Model x3
what model over-comes this and how?
Static: does NOT consider future+expectations/uncertainty
No account for time delays/costs - capital assumed to be instantly changed which unrealistic
Assumes firms can borrow to buy capital (constraints)
Tobin’s q, which relates stock market to investing decisions
What does tobin’s q = [words]
if q > 1
market value of installed capital/replacement cost of installed capital
firms buy more capital to raise market value of firm.
Re-Write Tobin’s q more formally….
all workings inc. geometric series
page 4
Sum to infinity formula for geometric series?
= a / (1-x)
what is alpha value and common factor for geo series?
F(P,K)/1+r
1 / 1+r
What factors cause change in investment in q model?
[hint: may have studied them before]
same as optimal capital stock factors
main factor added to q model?
current investment will also be influence by future values/cash flows of these variables - more dynamic
Adjustment Costs Rule to determine investment?
What does theeta represent
what happens to investment when q>1?
I = [1/theeta] * (q-1)
theeta installation costs
increase investment if q>1
Relationship between q and neoclassical?
If MPK > COC , profit rate high, stock market value high, thus q value high
