Unit III Invest Rates and Investment Demand
What is Investment?
- Money spent or expenditures on:
- New plants (factories)
- Capital equipment (machinery)
- Technology (hardware & software)
- Inventories(goods sold by producers)
Expected Rates of Return
- How does business make investment decisions?
- Cost/ benefit analysis
- How does business determine the benefits?
- Expected rate of return
- How does business count the cost?
- Interest costs
- How does business determine the amount of investment they undertake?
- Compare expected rate of return to interest cost
- If expected return > interest cost, then invest
- If expected return < interest cost, then do not invest
Real (r%) vs. Nominal (i%)
What’s the difference?
-Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post factor
- How do you compute the real interest rate (r%)?
- Formula: r% = i% - pi%
- What then, determines the cost of an investment decision?
- The real interest rate (r%)
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