Investment Demand and Interest Rates

Investment Demand

• Investment- money spend or expenditures on: new plants, physical capital, new technology, new homes, and inventories (goods sold by producers)
• Shape of the ID curve is downward sloping because, when interest rates are high, fewer investments are profitable; when investment rates are low, more investments are profitable

Shifts in Investment Demand

• Costs of production

  -Lower costs shift ID right
 - Higher costs shift ID left

• Business taxes

-Lower business taxes shift ID right
-Higher business taxes shift ID left

• Technological change

-New technology shift ID right
-Lack technology change shifts ID left

• Stock of Capital

-economy is low on capital, then ID shifts right
-economy has plenty of capital, then ID shifts left

• Expectations

-Positive expectations shift ID right

-Negative expectations shift ID left

Interest Rates

Expected Rates of Return

•  businesses make investment decisions with cost/benefit analysis
•  businesses determine the benefits of investment with the expected rate of return
•  business count the cost with the interest cost
• business determine the amount of Investment they undertake?                                       - Compare expected rate of return to interest cost                                                         - If expected return > interest cost, then investment should be made                             - If expected return < interest cost, then don't invest

Real Interest Rate (r%) vs Nominal Interest Rate (i%)

• Nominal is the observable rate of interest
• Real subtracts out inflation (π%) and is only known ex post facto (after the fact)
• real interest rate (r%) formula: r% = i% - π%