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
x3 Reasons for Relationship between stock market and GDP: {x4 chain, x3 chain, x1}
back of sheet 4
- Wave of pessimism about future profits
- Fall in stock prices
- lower stock prices may mean slow down in tech-progress and LR eco growth
impact of financing constraints…
x2 causes of constraints
what does neo assume?
Firms only able to invest their profits, can’t borrow
low profits and macro econ (recession)
assumes firms can borrow to buy capital whenever
What is residential Investment
x2 egs
change in stock of houses
purchase of new houses or building new rental properties
How residential investment is determined? 2 graphs
Sheet 5
Existing and New House market
Price in existing market determines no. of new builds
Show affect of fall in r on housing markets?
sheet 5
changes in housing demand
What do some economists believe this can cause?
changes in tax code; can sometimes act as deduction from mortgage interest (subsidy)
deduction applies to nominal mortgage rate so subsidy is higher when inflation higher
Some believe subsidy can cause over-investment in housing RELATIVE to other forms of capital
Inventory investment Def
size ___ but, in recession, accountable for _____
Why?
value of stock held but firms
1% of GDP but more than half fall in spending due to fall in I.I
in recession, firms let stock run out bc don’t want cash tied up in inventory assets
Motives for holding Inventories x4
Back of sheet 5
- production smoothing
- inventories as a factor of prod
- stock out avoidance
- Goods still in production process count
Accelerator model assumption {Eq & what is Beta}
firm hold stock of inventories proportional to output
N = Beta*Y ie buffer stock
Beta - exogenous parameter for desired stock as proportion of output
When Output is rising….
firm increase their inventories
[^output = ^ inventories]
Imperical evidence for accelerator model find beta =
0.2
what do all type of investment depend negatively on
real interest rate
investment is most ____ component of GDP
volatile
Investment volatility reasons x3 and their affects
Fluctuations in:
employment affects MPK
income affects residential investment
Output affects inventory investment
