Investment theory Flashcards
(27 cards)
reason why banks cut interest rates
stimulate investment
investment definition and goods
machines, computers, office furniture
investment, the use of valuable resources to produce more goods later.
aimed at providing a higher standard of living at a later date.
links the present to the futute
15-20% of GDP in developed economies
plays important role for short run business cycle fluctuations
volatile component of AD
flow of spending that adds to the physical stock of capital
capital stock
K, the way of accumulating future production capacity.
the given value of all the buildings machines and inventories at a point in time
types of investment spending
business fixed investment (equipement)
residential investment (new houses)
inventory investment ( change in quantity of goods in storage/stock)
rate of depreciation
delta- captures the fact that capital breaks, wears out over time or becomes obsolete.
capital stock will fall unless continually replenished
capital stock in next period
previously accumulated capital exist (K1), stock may differ in future from new investment or depreciation
K2 (capital stock next period) = K1 (capital stock this period) + I1 (gross investment this period) - ( deltaK1) depreciation this period)
investment and capital accumulation denoted by time
I_t (gross investment) = k_t+1 - k_t + deltaK_t
gross investment = change in the capital stock (net investment) + replacement of worn out capital (depreciation)
The Neoclassical model of investment
firms use resources to produce more goods later- investment/ fixed capital formation
firms accumulate capital when profitable (depending on expected future profits)
if profitable firms wither borrow to invest and pay interest or use its own funds and fogoe interest payment
what is slope of production function
marginal productivity of capital
how to find MPK and what is
partially differentiate the production function with respect to K
MPK= DY/DK
amount of extra output that can be obtained when an additional unit of K is installed
this is diminishing
how are investment decisions made
optimal K
firms decide optimal capital stock then decide how much to inves to reach
optimal capital stock depends of production tech
firms will perform cost benefit analysis in order to decide optimal K to max profits
Benefits of Investment
assume K has a resale price
buy K this period and sell it next for market price
marginal benefit from investing one extra unit of capital is…..
MPK + (1-delta)
marginal product + resale value
Cost of investment
one unit of investment is financed by other resources that could be invested in other financial assets, opportunity cost of investment is 1+r
one unit of investment is financed by borrowing marginal cost of capital is 1 + r
firms must balance contributing more capital makes to their revenue against the cost of more K
optimal K
k* is when marginal benefits are equal to marginal costs
MPK = r + delta
K* = r+delta
r+ delta is the user cost of capital
as long as MPK is above user cost of capital it pays the firm to add to its stock of K, so firms will keep investing until the value of output produced by adding one more unit of K is equal to the cost of adding that unit of K
impact of increased interest rate on capital stock
capital stock decreases
what does investment depend on equation
I_t= K-t+1 - K_t + deltaK_t = k* - k_t + delta Kt
Fisher Equation
r = i - pie
squeeze on income due to inflation
The accelerator principle
in aggregate firms make investment decisions based on changes in output (real GDP)
provides an explanation into why investment is more volatile than output
each level of output needs a specific amount of capital so that v=k/y
economy always requires a fixed amount of K per unit of Y
so K* = vY
investment due to the accelerator principle would be…
I1 = K*2 - k1 = v(Y2-Y1) = xChange in Y2
for I to remain constant Y must increase proportionately every period
i increases Y has to accelerate
increase in investment = acceleration of output
an explanation for why investment is observed to be more volatele than Y
Firms borrowing constraint- cant always invest at optimal level
- I(t) might depend on available cash flow, cashflow depends on profits, profits depend on output growth and ability to invest depends on output growth
Tobin’s q
provides a link between stock markets and the amount of investment in new capital by firms
linking financial factors and real economic variables
share prices reflect the best estimate of the value of a firm (the present discounted value of current and expected profits)
Tobin’s q
Market value of installed capital/ replacement cost of installed capital
market valuation of the firm (share value), to the value of the firms capital stock
what does tobin q tell us
if q >1 then investment > 0 because the market value of K is higher than it’s purchase price
if q<1 then investment < 0 because it’s profitable to sell or dismantle the firm’s capital stock
Tobin’s q- Effect of r
stock market values firms by discounting future earnings, increasing r, lower stock prices, lower q lower investment (i)
Tobins q: effect of technology
technological improvement increases expected future profitability of firms, stock value increases, q increases investment increases (tech stock boom)
