Unit 3 - Feb 26 (Interest Rate vs. Investment Rate)

Investment - money spent or expenditure on:

• New plans (factories)
• Capital equipment (machinery)
• Technology (hardware/software)
• New homes
• Inventories (goods sold by producers)

Expected Rate of Return

• How does business make investment decision?
• 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 to interest cost.
• Expected cost > interest cost, then invest.
• Expected cost < interest cost, then don't invest.

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

• Differences?
• Nominal - observable rate of interest.
• Real - subtracts out inflation(π %) and is only known ex post facto.
• Real interest rate (r %)
• r % = i % - π %
• What determine the cost of investment decision?
• The real interest rate (r %).

Investment Demand Curve (ID)

• Downward sloping.
• Why?
• When interest rate is high, fewer investments are profitable.
• When interest rate is low, more investments are profitable.
• Determinants
1. Cost of production
2. Business tax
3. Technological changes
4. Stock of capital
5. Expectation