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14.2 factors of Investment

Learning Objectives

draw a hypothetical investment demand curve, and explain what the shows around the relationship between investment and also the attention rate. Comment on the components that can cause an investment need curve to shift.

We will see in this section that interest prices play a vital role in the determination of the desired stock the capital and also thus that investment. Since investment is a procedure through which funding is enhanced in one period for usage in future periods, expectation play an essential role in invest as well.

You are watching: A rightward shift of the investment demand curve might be caused by:

Capital is one factor of production, together with labor and also natural resources. A decision to invest is a decision to use an ext capital in developing goods and services. Components that influence firms’ choices in the mix of capital, labor, and also natural resources will influence investment together well.

We will also see in this ar that public policy affects investment. Part investment is excellent by federal government agencies as they include to the public stock of capital. In addition, the tax and also regulatory plans chosen by the public sector can influence the investment options of exclusive firms and individuals.

Interest Rates and also Investment

We frequently hear reports that low interest prices have stimulated housing construction or the high prices have decreased it. Such reports indicate a an adverse relationship in between interest rates and investment in residential structures. This relationship applies to all develops of investment: greater interest rates tend to minimize the quantity of investment, while lower interest rates rise it.

To check out the relationship between interest rates and investment, expect you very own a tiny factory and also are considering the surroundings of a solar power collection mechanism to warm your building. Friend have identified that the expense of installing the system would be $10,000 and also that the mechanism would reduced your energy bills by $1,000 per year. To simplify the example, we shall expect that these savings will continue forever and also that the system will never need repair or maintenance. Thus, we require to take into consideration only the $10,000 acquisition price and the $1,000 annual savings.

If the device is installed, it will be an addition to the funding stock and will thus be counted together investment. Must you acquisition the system?

Suppose the your business already has the $10,000 on hand. You are considering even if it is to usage the money because that the solar energy system or for the purchase of a bond. Her decision to purchase the system or the link will count on the interest price you might earn ~ above the bond.

Putting $10,000 into the solar energy system generates an effective income the $1,000 every year—the saving the device will produce. The is a return that 10% every year. Suppose the bond yields a 12% yearly interest. It therefore generates interest earnings of $1,200 per year, enough to pay the $1,000 in heating bills and also have $200 left over. In ~ an interest rate of 12%, the bond is the far better purchase. If, however, the interest price on bonds were 8%, then the solar power system would certainly yield a greater income than the bond. At attention rates listed below 10%, you will invest in the solar power system. At attention rates over 10%, you will buy a shortcut instead. At an interest price of precisely 10%, that is a toss-up.

If you carry out not have the $10,000 ~ above hand and would should borrow the money to purchase the solar energy system, the interest rate still governs your decision. At interest rates listed below 10%, it provides sense come borrow the money and also invest in the system. At interest rates above 10%, the does not.

In effect, the interest price represents the opportunity expense of placing funds right into the solar energy system fairly than into a bond. The price of placing the $10,000 right into the mechanism is the attention you would forgo by not purchasing the bond.

At any one time, millions of investment choices hinge on the interest rate. Every decision come invest will make sense at part interest rates yet not in ~ others. The greater the attention rate, the under potential investments will certainly be justified; the lower the attention rate, the better the number that will be justified. There is for this reason a an adverse relationship between the interest rate and also the level the investment.

Figure 14.7 "The Investment demand Curve" reflects an investment need curveA curve that mirrors the quantity of invest demanded at each interest rate, through all other determinants of investment unchanged. Because that the economy—a curve that reflects the amount of investment demanded in ~ each attention rate, through all other factors of invest unchanged. At an interest rate of 8%, the level of invest is $950 billion every year at allude A. At a reduced interest rate of 6%, the investment demand curve mirrors that the quantity of investment demanded will climb to $1,000 billion every year at point B. A palliation in the interest price thus reasons a movement along the investment need curve.

Figure 14.7 The Investment demand Curve


The investment demand curve reflects the volume of investment spending every year in ~ each interest rate, assuming all other determinants of investment room unchanged. The curve mirrors that as the interest price falls, the level of investment per year rises. A reduction in the interest rate from 8% to 6%, because that example, would rise investment native $950 billion to $1,000 billion every year, all other factors of investment unchanged.

Heads Up!

To make feeling of the relationship in between interest rates and also investment, you should remember that investment is an enhancement to capital, and that resources is miscellaneous that has been produced in stimulate to develop other goods and also services. A link is not capital. The acquisition of a link is not an investment. We deserve to thus think of purchasing bonds together a financial investment—that is, as an different to investment. The more attractive bonds space (i.e., the greater their interest rate), the much less attractive investment becomes. If we forget that investment is an addition to the resources stock and also that the purchase of a shortcut is not investment, we can autumn into the adhering to kind that error: “Higher attention rates median a better return ~ above bonds, so more people will acquisition them. Greater interest prices will because of this lead to better investment.” that is a mistake, of course, due to the fact that the purchase of a link is not an investment. Greater interest rates boost the opportunity cost of utilizing funds because that investment. They reduce investment.

Other components of investment Demand

Perhaps the most vital characteristic that the investment need curve is not its an adverse slope, but rather the reality that it move often. Back investment absolutely responds to alters in interest rates, alters in other factors show up to beat a more important duty in driving invest choices.

This ar examines eight extr determinants of invest demand: expectations, the level of economic activity, the stock of capital, volume utilization, the cost of funding goods, other element costs, technological change, and public policy. A readjust in any type of of these can transition the investment need curve.


A change in the resources stock alters future manufacturing capacity. Therefore, to plan to adjust the funding stock count crucially on expectations. A certain considers likely future sales; a student weighs future in various occupations and their required educational and training levels. Together expectations readjust in a means that increases the intended return native investment, the investment need curve shifts to the right. Similarly, expectation of reduced profitability shift the investment need curve to the left.

The Level of financial Activity

Firms need funding to develop goods and services. An increase in the level of manufacturing is most likely to boost demand because that capital and thus lead to greater investment. Therefore, an increase in GDP is most likely to change the investment need curve come the right.

To the degree that boost in GDP increases investment, the multiplier effect of an initial adjust in one or much more components of accumulation demand will be enhanced. Us have currently seen the the boost in manufacturing that occurs through an initial boost in accumulation demand will increase household incomes, i beg your pardon will boost consumption, thus creating a more increase in aggregate demand. If the increase also induces this firm to increase their investment, this multiplier effect will be even stronger.

The share of Capital

The quantity of capital currently in use affects the level of invest in two ways. First, since most invest replaces resources that has depreciated, a greater funding stock is most likely to lead to more investment; there will be an ext capital to replace. Yet second, a greater capital stock have the right to tend to reduce investment. That is because investment occurs to adjust the share of capital to its desired level. Given that desired level, the quantity of investment necessary to reach it will be lower when the current funding stock is higher.

Suppose, because that example, that genuine estate experts expect the 100,000 homes will be essential in a specific community through 2010. The will create a boom in construction—and therefore in investment—if the current number of houses is 50,000. Yet it will produce hardly a ripple if over there are now 99,980 homes.

How will these conflicting effects of a larger capital stock kind themselves out? due to the fact that most investment occurs to change existing capital, a larger capital stock is most likely to increase investment. But that larger funding stock will absolutely act to alleviate net investment. The much more capital already in place, the less brand-new capital will certainly be forced to with a offered level of resources that may be desired.

Capacity Utilization

The capacity utilization rateA measure up of the percentage of the capital stock in use. Steps the percentage of the capital stock in use. Due to the fact that capital typically requires downtime for maintenance and repairs, the measured capacity utilization rate commonly falls listed below 100%. For example, the average production capacity utilization price was 79.7% because that the period from 1972 to 2007. In November 2008 that stood at 72.3.

If a large percentage that the current funding stock is gift utilized, this firm are more likely to boost investment 보다 they would certainly if a big percentage the the capital stock to be sitting idle. During recessions, the volume utilization rate tends to fall. The reality that that company have an ext idle volume then depresses investment even further. Throughout expansions, as the capacity utilization price rises, firms wanting to produce much more often must rise investment to execute so.

The price of funding Goods

The need curve because that investment reflects the quantity of investment at each attention rate, all other things unchanged. A adjust in a variable held consistent in drawing this curve shifts the curve. Among those variables is the price of capital goods themselves. If, for example, the building cost of brand-new buildings rises, climate the quantity of invest at any kind of interest price is most likely to fall. The investment need curve thus shifts to the left.

The $10,000 price of the solar power system in the example given earlier absolutely affects a decision to purchase it. We witnessed that to buy the mechanism makes feeling at interest rates listed below 10% and also does no make feeling at interest rates over 10%. If the system expenses $5,000, climate the attention return on the investment would certainly be 20% (the annual saving the $1,000 split by the $5,000 early cost), and the investment would be undertaken at any interest rate listed below 20%.

Other factor Costs

Firms have a selection of options concerning how particular goods deserve to be produced. A factory, because that example, could use a innovative capital facility and also relatively couple of workers, or it could use an ext workers and relatively less capital. The an option to use capital will be impacted by the price of the funding goods and the attention rate, yet it will also be affected by the cost of labor. As labor costs rise, the need for capital is likely to increase.

Our solar energy collector example suggests that energy prices influence the need for resources as well. The presumption that the system would conserve $1,000 every year in energy prices must have been based upon the price of fuel oil, herbal gas, and also electricity. If these prices to be higher, the savings indigenous the solar power system would be greater, raising the demand for this form of capital.

Technological Change

The implementation of brand-new technology often requires brand-new capital. Alters in modern technology can for this reason increase the need for capital. Advancements in computer technology have encouraged massive investments in computers. The development of fiber-optic technology for transmitting signals has actually stimulated huge investments by telephone and also cable television companies.

Public Policy

Public policy can have significant effects on the demand for capital. Such policies commonly seek to influence the expense of funding to firms. The Kennedy management introduced two such tactics in the early 1960s. One strategy, sped up depreciation, permitted firms to depreciate funding assets end a very short period of time. They can report artificially high production expenses in the first years of one asset’s life and also thus report reduced profits and also pay lower taxes. Sped up depreciation did not readjust the actual rate at i beg your pardon assets depreciated, the course, however it cut tax payments during the beforehand years that the assets’ use and also thus reduced the expense of hold capital.

The second strategy to be the investment taxation credit, which permitted a for sure to reduce its taxation liability by a percentage of its investment during a period. A certain acquiring new capital can subtract a fraction of that cost—10% under the Kennedy administration’s plan—from the count it owed the government. In effect, the federal government “paid” 10% that the cost of any brand-new capital; the investment taxation credit thus diminished the expense of capital for firms.

Though less direct, a 3rd strategy for stimulating investment would be a reduction in count on corporate earnings (called the corporate income tax). Better after-tax profits typical that firms have the right to retain a greater section of any type of return on an investment.

A 4th measure to encourage better capital buildup is a resources gains tax rate that enables gains on legacy held throughout a certain duration to be taxed at a various rate than various other income. As soon as an heritage such as a building is offered for more than its purchase price, the seller the the legacy is claimed to have actually realized a capital gain. Together a gain can be taxed as revenue under the an individual income tax. Alternatively, it might be taxed at a lower rate reserved solely for such gains. A lower resources gains tax price makes assets topic to the tax much more attractive. It therefore increases the need for capital. Congress diminished the resources gains tax rate from 28% to 20% in 1996 and also reduced the forced holding duration in 1998. The Jobs and also Growth taxation Relief Reconciliation plot of 2003 decreased the resources gains tax more to 15% and likewise reduced the tax price on dividends from 38% to 15%. A proposal to eliminate resources gains taxation for smaller sized firms to be considered yet dropped before the stimulus invoice of 2009 was enacted.

Accelerated depreciation, the investment tax credit, and lower counting on that company profits and capital benefit all boost the need for personal physical capital. Windy policy deserve to also impact the demands for other forms of capital. The federal government subsidizes state and also local government production that transportation, education, and also many other infrastructure to encourage higher investment in public ar capital. For example, the federal government pays 90% that the price of investment by local federal government in new buses for public transportation.

Key Takeaways

The quantity of invest demanded in any period is negatively related to the attention rate. This connection is portrayed by the investment demand curve. A adjust in the attention rate reasons a motion along the investment demand curve. A adjust in any type of other determinant that investment reasons a transition of the curve. The other components of investment incorporate expectations, the level of financial activity, the stock of capital, the volume utilization rate, the expense of resources goods, other variable costs, technical change, and also public policy.

Try It!

Show just how the investment demand curve would certainly be influenced by every of the following:

A sharp increase in taxes on profits earned by firms an increase in the minimum fairy The expectation the there will certainly be a sharp upsurge in the level that economic activity An boost in the expense of new capital goods rise in attention rates rise in the level that economic activity A organic disaster that destroys a far-ranging fraction that the capital stock

Figure 14.8


The U.S. Economy was widening in 2004, yet there to be a feeling that it still was no functioning and it could, as job growth was fairly sluggish. To shot to spur growth, Congress, supported by chairman Bush, pass a law in 2004 dubbed the American Jobs development Act that provided businesses a one-year special taxation break on any type of profits accumulating abroad that were moved to the unified States. Such earnings are called repatriated profits and also were estimated at the time to be around $800 billion. Because that 2005, the tax price on repatriated profits basically fell indigenous 25% to 5.25%.

Did the taxes break have actually the preferred effect on the economy? to some extent yes, though business also found other offers for the repatriated funds. There were 843 companies that repatriated $312 billion the qualified for the taxes break. The Act therefore generated around $18 billion in tax revenue, a greater level than had actually been expected. Some providers announced they to be repatriating profits and also continuing come downsize. For example, Colgate-Palmolive brought ago $800 million and also made recognized it to be closing a 3rd of its factories and also eliminating 12% of its workforce. However, various other companies’ to plan seemed an ext in line through the objectives of the special taxation break—to produce jobs and also spur investment.

For example, spokesman lining Mulloy the Intel, i beg your pardon repatriated end $6 billion, claimed the firm was building a $3-billion wafer fabrication facility and spending $345 million on expanding existing facilities. “I can’t say dollar-for-dollar how much the the capital for those comes from off-shore cash,” yet he felt that the repatriated funds to be contributing to Intel’s overall investments. Spokeswoman Margaret Graham of Bausch and also Lomb, which provides eye-care products and repatriated $805 million, said, “We arrangement to use that cash for funding expenditures, investment in research and development, and also paying nonofficer compensation.”

Analysts space skeptical, though, that the repatriated earnings really contributed to investment. The New York Times report on one research that suggested it had actually not. Rather, the repatriated accumulation were supplied for other purposes, such together stock repurchases. The dispute is the the companies made investments that they were planning to make and the repatriated funds essentially freed up funding for various other purposes.

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Sources: Timothy Aeppel, “Tax rest Brings billion to U.S., But impact on rental Is Unclear,” Wall Street Journal, October 5, 2005, p. A1; Lynnley Browning, “A One-Time taxes Break conserved 843 U.S. Companies $265 Billion,” New York Times, June 24, 2008, p. C3.

Answers to try It! Problems

The investment demand curve shifts to the left: panel (b). A higher minimum wage renders labor much more expensive. This firm are likely to shift to better use that capital, so the investment demand curve move to the right: dashboard (a). The investment demand curve move to the right: panel (a). The investment need curve move to the left: dashboard (b). Boost in attention rates reasons a activity along the investment demand curve: dashboard (c). The investment demand curve shifts to the right: dashboard (a). The should replace resources shifts the investment demand curve to the right: panel (a).