02/26/14 Interest Rates & Investment Demand

• What is investment?
• Money spent or expenditures on:
• New Plants (factories)
• Capital Equipment (machinery)
• Technology (hardware and software)
• New Homes
• Inventories (goods sold by producers)
• Expected Rates of Return
• How does business make investment decisions?
• Cost/benefit analysis
• How does business determine the benefits?
• Expected rate of return
• How does business count the cost?
• Interest cost
• How does business determine the amount of investment they undertake?
• Compare expected rate of return no interest cost.
• If expected return> interest cost, then invest.
• If expected return< interest cost, then do not invest.
• Real (r%) v. Nominal (n%)
• What is the difference?
• Nominal is the observable rate of interest real subtracts out inflation (pi%) and is only known ex post factos.
• How do you compute the real interest rate (r%)?
• r%= i%-pi%
• What then, determines the cost of an investment decision?
• The real interest rate (r%)
• Investment Demand Curve (ID)
• What is the shape of the investment demand curve?
• Always downward sloping.
• Why?
• When interest rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable.
• Shifts in Investment Demand (ID)
1. Cost of Production
2. Business Taxes
3. Technological Change
4. Stock of Capital 
5. Expectations