Economics: Unit 3-Interest Rates and Investment Demand

Interest Rates and Investment Demand 

What is an investment?

---Money spent or expenditures on:

• New Plants (factories)
• Capital Equipment 
• Technology (hardware and software)
• Now Homes
• Inventories (goods sold by producers)

Expected Rates of Return

• How does business make investment decisions?
• Cost or benefits analysis
• How does businesses determine the benefit?
• Expected rate of return
• How does businesses count the cost?
• Interest costs
• How does business determine the amount of investment they undertake?
• Compare expected rate of return to interest cost
• If the expected return is greater then the interest cost, then people should invest
• If the expected return is smaller then the interest cost, then people should NOT invest

Real (r%) vs. Nominal (i%)

What's the difference?

• Nominal is the observable rate of interest.
• Real subtracts out inflation and is only known as ex post facto

How do you compare the real interest rate (r%)?

• r% = (i%) - inflation (pie%)

What then, determines the cost of investment of an investment decision?

• The real interest rate (r%)

Investment Demand Curve (ID)

What is the shape of the investment demand curve?

• Downward sloping

Why?

• When interest rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable

Shifts in the Investment Demand (ID)

• Cost of Production
• Business taxes
• Technological Change
• Stock of Capital 
• Expectation