T2: Topic 4: Investment Flashcards
See
graphs/data page 2 slides
3 components of investment, and what they are?
1) Business fixed investment: includes equipment/structures firms purchase to use in production process
2) Residential investment: includes owner occupied housing and housing purchased to rent out
3) includes goods which firms put aside for storage (eg. WIP, supplies, materials)
What do firms tend to run down during recessions? (2) What does this mean
Inventories (see data page 3)
Pre-recession investments
Pro-cyclical tf +ve association between I and GDP
Note
I more volatile than C
Explain business fixed investment in detail?
The largest component of investment spending (approx. ¾ of the total); we therefore spend the most time on this component.
‘Business’: Firms investing to facilitate future production.
‘Fixed’: Firms hold onto this capital; in contrast to inventories which will be sold or used within a short period of time.
Examples: Factories, company cars, computers, office furniture.
2 types of firms considered by Neoclassical Model of Investment (NMoI)?
1) Production firms = produce goods and services using rented capital
2) Rental firms = purchases capital to rent it out to production firms
How do production firms choose how much capital to rent?
By comparing the cost and benefit of each unit of capital
Rents at R/unit
Sells at P/unit
tf Real cost of 1 unit of capital=R/P
Draw a production firms’ capital supply and MPk on a diagram?
See notes
For a CD PF, what is capital’s normal rough share of output?
1/3 (alpha=1/3)
Interpretation of 𝑀𝑃𝐾 = 𝑅/𝑃 = 𝛼𝐴(𝐿/𝐾)^(1−𝛼) ? (3)
1) The lower the stock of capital, the higher the real rental price of capital
2) The greater the amount of labour employed, the higher the real rental price of capital (comp. goods)
3) The better the technology, the higher the real rental price of capital
Benefit of owning K for rental firms?
R/P per unit
3 costs of owning capital for rental firms?
1) If firm borrows to buy K, it incurs a nominal interest rate, i; even if they don’t borrow, i still represents opportunity cost
2) Price of K can change whilst out on loan
3) Capital depreciates whilst out on loan
What does Pk/P represent in real cost of capital equation?
The relative price of goods
How do rental firms determine whether to increase/decrease amount of capital stock owned?
Real profit/unit determines their net investment
If MP(k)>cost of capital firm profits
Prove the profit rate equation for rental firms
see notes
Note
In reality firms are likely to be part type 1 and part type 2 firms
tf benefit=MP(k), cost=cost of capital
Difference between gross investment and net investment? What does this mean when they are compared?
Gross investment includes depreciation, net investment doesn’t.
Means that gross investment is always the higher value/line if on a graph
Why does gross investment get a different value to net investment?
gross investment counts ‘replacement investment’ as investment
Explain the relationship between I and r, and draw graph?
Decrease r -> decrease P(k) -> increase profit from owning K -> increase incentive to own K tf increase in investment (and vice versa)
See notes for diagram
How would an improvement in technology affect investment?
Anything (inc. technology) that increases the marginal product of capital will increase the profitability of investment tf increase investment