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Chap 17 Ecn 302

Chapter 17 discusses investment in macroeconomics, covering three types: business fixed investment, residential investment, and inventory investment. It explains the relationship between investment and interest rates, factors affecting the investment function, and the behavior of investment during economic cycles. Additionally, it highlights the motives for holding inventories and introduces the Accelerator Model to explain inventory investment behavior.

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Wakil Abdullah
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16 views19 pages

Chap 17 Ecn 302

Chapter 17 discusses investment in macroeconomics, covering three types: business fixed investment, residential investment, and inventory investment. It explains the relationship between investment and interest rates, factors affecting the investment function, and the behavior of investment during economic cycles. Additionally, it highlights the motives for holding inventories and introduces the Accelerator Model to explain inventory investment behavior.

Uploaded by

Wakil Abdullah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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CHAPTER

17
Investment

MACROECONOMICS SIXTH EDITION

N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
In this chapter, you will learn…

▪ leading theories to explain each type of


investment
▪ why investment is negatively related to the
interest rate
▪ things that shift the investment function
▪ why investment rises during booms and falls
during recessions

CHAPTER 17 Investment slide 1


Three types of investment

▪ Business fixed investment:


businesses’ spending on equipment and
structures for use in production.
▪ Residential investment:
purchases of new housing units
(either by occupants or landlords).
▪ Inventory investment:
the value of the change in inventories
of finished goods, materials and supplies,
and work in progress.
CHAPTER 17 Investment slide 2
U.S. investment and its components
Billions 200
of 1996 0 Total investment
175
dollars 0 Business fixed investment
150
0 Residential investment
125
0
Change in inventories
100
0
75
0
50
0
25
0
0
-25
0 197 197 198 198 199 199 200 200
0 5 0 5 0 5 0 5
CHAPTER 17 Investment slide 3
Understanding business fixed
investment
▪ The standard model of business fixed
investment:
the neoclassical model of investment
▪ Shows how investment depends on
▪ MPK
▪ interest rate
▪ tax rules affecting firms

CHAPTER 17 Investment slide 4


Two types of firms

▪ For simplicity, assume two types of firms:


1. Production firms rent the capital they use
to produce goods and services.
2. Rental firms own capital, rent it to
production firms.

In this context,
“investment” is the rental firms’
spending on new capital goods.

CHAPTER 17 Investment slide 5


The capital rental market
real rental
Production firms cap
price, R/P
must decide how ital
much capital to rent. supply
Recall from Chap. 3:
Competitive firms capita
rent capital to the l demand
point where (MPK
MPK = R/P. equilibrium )
rental rate K
capital
stock
CHAPTER 17 Investment slide 6
Factors that affect the rental price

For the Cobb-Douglas


production function,
the MPK (and hence
equilibrium R/P ) is

The equilibrium R/P would increase if:


▪ ↓K (e.g., earthquake or war)
▪ ↑L (e.g., pop. growth or immigration)
▪ ↑A (technological improvement, or deregulation)
CHAPTER 17 Investment slide 7
Rental firms’ investment decisions

▪ Rental firms invest in new capital when the


benefit of doing so exceeds the cost.
▪ The benefit (per unit capital):
R/P, the income that rental firms earn
from renting the unit of capital to
production firms.

CHAPTER 17 Investment slide 8


The cost of capital
Components of the cost of capital:
interest cost: i ×PK,
where PK = nominal price of capital
depreciation cost: δ ×PK,
where δ = rate of depreciation
capital loss: − ΔPK
(a capital gain, ΔPK > 0, reduces cost of K )
The total cost of capital is the sum of these
three parts:

CHAPTER 17 Investment slide 9


The cost of capital
Nominal cost
of capital

Example: car rental company (capital: cars)


Suppose PK = $10,000, i = 0.10, δ = 0.20,
and ΔPK/PK = 0.06

Then, interest cost = $1000


depreciation cost = $2000
capital loss = − $600
total cost = $2400
CHAPTER 17 Investment slide 10
The cost of capital

For simplicity, assume ΔPK/PK = π.

Then, the nominal cost of capital equals


PK(i + δ − π) = PK(r +δ )

and the real cost of capital equals

The real cost of capital depends positively on:


▪ the relative price of capital
▪ the real interest rate
▪ the depreciation rate
CHAPTER 17 Investment slide 11
The rental firm’s profit rate

A firm’s net investment depends on its profit rate:

▪ If profit rate > 0,


then increasing K is profitable
▪ If profit rate < 0, then the firm increases profits by
reducing its capital stock.
(Firm reduces K by not replacing it as it depreciates.)

CHAPTER 17 Investment slide 12


Inventory investment

Inventory investment is only about


1% of GDP.
Yet, in the typical recession,
more than half of the fall in spending
is due to a fall in inventory investment.

CHAPTER 17 Investment slide 13


Motives for holding inventories

1. production smoothing
Sales fluctuate, but many firms find it cheaper to
produce at a steady rate.
▪ When sales < production, inventories rise.
▪ When sales > production, inventories fall.

CHAPTER 17 Investment slide 14


Motives for holding inventories

1. production smoothing
2. inventories as a factor of production
Inventories allow some firms to operate more
efficiently.
▪ samples for retail sales purposes
▪ spare parts for when machines break down

CHAPTER 17 Investment slide 15


Motives for holding inventories

1. production smoothing
2. inventories as a factor of production
3. stock-out avoidance
To prevent lost sales when demand is higher
than expected.

CHAPTER 17 Investment slide 16


Motives for holding inventories

1. production smoothing
2. inventories as a factor of production
3. stock-out avoidance
4. work in process
Goods not yet completed are counted in
inventory.

CHAPTER 17 Investment slide 17


The Accelerator Model

A simple theory that explains


the behavior of inventory investment,
without endorsing
any particular motive

CHAPTER 17 Investment slide 18

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