Week 5: Investments Flashcards
3 Types of Business investment
- Business Investment - spending on new capital assets
- Inventory Investment - spending on raw materials
- Housing Investment - spending on housing
2 Investment Tools
- Compounding
- Discounting
Define Compounding
- used to determine worthwhileness of an investment
- how money grows over time when you leave it to accumulate interest
- interest is earned on initial deposit and previously earned interest (wealth compounds)
- money in the bank is multiplied by 1 + r for each yr
Define Discounting
- converts future values into current values to see if the investment is worthwhile
What is the interest rate in investment?
the rate of return you can get from investing funds into next best alternative
What criteria do firms use to make decisions on investing in capital?
- cost of investment
- return to investment
- present value of benefits exceeds the present value of costs
Define Depreciation
decline in capital due to wear and tear
rational rule for investors
do the investment if present value of future revenues is greater than up-front costs
Investment is dependent on…
- expectations about future revenues
- real interest rate r
- depreciation rate d
- real cost of capital C
Why is the market for loanable funds important?
determines long-run real interest rate + quantity of investment
- savers = supply
- investors = demand
What is the long-run real interest rate
evolves slowly over many yrs dur to balance of saving and investment
What is the short-run real interest rate
rises + falls each month with adjustments from Central Bank
Neutral real interest rate is
the interest rate when economy’s actual output is equal to potential
Factors that shift Demand Line
- Technology
- Expectations
- Corporate Taxes
- Lending Standards and Cash Reserves
Factors that shift Supply Line
- Personal Savings Rate
- Budget Surplus/Deficit and Increase/Decrease Government Saving
- Global shocks affect foreign saving
