Topic 12: Investment

Question 1

What is the equation for the recurring cost of a unit of capital?

If we assume r = i - π how can we include r in this equation?

Answer 1

= P_K(i+δ) - ΔP_K

= P_K(i+δ) - (1 + π)P_K-P_K

= P_K(i + δ - π)

= P_K(r + δ)

Question 2

What is the equation for profit per unit of capital?

Answer 2

P_YMP_K(L,K)-P_K(r+δ)

P_YMP_K(L,K) = AC

As L is fixed, K is variable and perfect competition is asssumped, so Py adjusts until that condition is met.

Question 3

Give the equation for the expected return on capital

Answer 3

r_C= P_YMP_K(L,K)/P_K-δ

Question 4

Give the equation for the rate of profit

Answer 4

r_C - r

Question 5

Give the equation for total investment.

Answer 5

I = I_N(r_c^e - r) + δK

Question 6

What is Tobin’s Q

Answer 6

The rule that firms baase their investment decisions on the ratio

Q = market value of installed capital (depenent on r_C^e)/replacement cost of installed capital.