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# Investment

Macroeconomic Theory I

ECON222

Fall 2017

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 1 / 12

The role of investment

## Here we are referring to spending on physical capital goods

Accounts for about 20% of GDP on average, but uctuates sharply
,! contributes about 50% of the total decline in GDP during recessions

## Investment is crucial for the long-run productive capacity of the

economy and its growth.

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 2 / 12

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 3 / 12
The desired capital stock basic model

## Managers compare the cost and benet of using additional capital,

e.g. a new machine.
,! the rms benet is MPK f the future MPK.
,! the rms cost is the user cost of capital.

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 4 / 12

The user cost of capital

This is the expected real cost of using a unit of capital for a specied
period of time

It can be expressed as
uc = (r + d )pK
where

## = the expected real rate of interest

r
d = the rate at which capital depreciates
pK = the real price of capital goods

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 5 / 12

Determining the desired capital stock

equals uc

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 6 / 12

\$

uc1

f
MPK

K*1 K
Figure: Determination of desired capital

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 7 / 12

Changes in the desired capital stock

## If r falls, uc falls =) MPK f > uc, and so K rises

,! the same is true when d or pK fall

## When technology improves, the MPK f curve shifts up

=) MPK f > uc and so K rises.

\$

uc2
uc1

f
MPK

K*2 K*1 K

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 9 / 12

Taxes and the desired capital stock

(1 )MPK f

uc
MPK f =
1
| {z }

## Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 10 / 12

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 11 / 12
Investment dynamics

## Let It denote gross investment in period t

,! the total purchase or construction of new capital goods

## Net investment (the change in the capital stock) is then

Kt + 1 Kt = It d.Kt

If Kt +1 = K , desired investment is

Itd = K (1 d ) Kt