Investment
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Investment: most volatile component of GDP

3 Types of Investment spending:

(i.) Business Fixed Investment: investment goods (equipment & structures bought) by firms

for future production

(ii.) Residential Investment: includes new housing people buy to live in & landlords buy to

rent.

(iii.) Inventory Investment: includes those goods businesses put aside in storage, incl.

Materials & supplies, work in progress, and finished goods.

Why is inv negatively related to the i. rate?

All types of inv inversely related to the real i. rate.

Higher i. rate: - raises cost of capital to firms that invest in plant,

-         raise cost of borrowing to home buyers,

-         raise cost of holding inventories.

What causes the investment function to shift?

Various causes: - an improvement in the available technology raises marginal product of capital &

raises business fixed investment.

- an increase in population raises demand for housing & raises residential inv.

- Most imp: various eco policies, such as Δs in the investment tax credit and

corporation tax, alter the incentive to invest & thus shift inv function.

Why does inv rise during booms & fall during recessions?

-         Natural to expect inv to be volatile over the business cycle, cos inv spending depends on outputas well as i. rates.

-         In Neoclassical model of business fixed inv, higher employment raises marginal product of capital & the incentives to invest.

-         Higher output: raises firms’ profits, relaxing financing constraints.

-         Higher Output: raises stock of inventories firms wish to hold, stimulating inventory inv.

-         Higher income: raises demand for houses, in turn raising house Ps and residential inv.

1. Business Fixed Investment

Neoclassical Model of Investment: examines costs & benefits to firms of owning capital goods.

Shows how level of fixed investment is related to (i.) Marginal Product of Capital, (ii.) The Interest rate, & (iii.) The Tax Rules Affecting Firms.

Other Notes in this Category

1. Investment
2. Investment Exam Questions
3. Macroecomic Questions : The Structure of the British Economy
4. Money Demand Exam Questions
5. Unemployment Exam Questions

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