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14.2 factors of Investment

Learning Objectives

attract a theoretical investment demand curve, and also explain what that shows around the relationship between investment and the interest rate. Talk about the factors that can cause an investment need curve to shift.

We will watch in this section that interest prices play a key role in the determination of the desired stock of capital and also thus that investment. Due to the fact that investment is a process through which capital is increased in one duration for usage in future periods, expectation play an essential role in investment as well.

You are watching: A rightward shift of the investment demand curve will:

Capital is one factor of production, along with labor and also natural resources. A decision to invest is a decision come use much more capital in developing goods and services. Determinants that affect firms’ options in the mix that capital, labor, and also natural sources will influence investment as well.

We will likewise see in this section that public policy affects investment. Part investment is excellent by federal government agencies together they include to the general public stock the capital. In addition, the tax and also regulatory plans chosen by the general public sector can influence the investment selections of personal firms and also individuals.

Interest Rates and Investment

We often hear reports the low interest prices have created housing building and construction or the high rates have lessened it. Such reports imply a an unfavorable relationship in between interest rates and also investment in residential structures. This relationship applies to all develops of investment: greater interest rates tend to mitigate the quantity of investment, while lower interest rates rise it.

To check out the relationship between interest rates and also investment, suppose you very own a tiny factory and also are considering the surroundings of a solar power collection mechanism to warmth your building. You have determined that the price of installation the mechanism would be $10,000 and also that the system would reduced your energy bills through $1,000 every year. To leveling the example, we shall mean that this savings will continue forever and that the system will never need repair or maintenance. Thus, we need to think about only the $10,000 purchase price and the $1,000 yearly savings.

If the system is installed, it will be an addition to the capital stock and also will therefore be counted as investment. Should you purchase the system?

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

Putting $10,000 right into the solar power system generates an reliable income that $1,000 per year—the conserving the mechanism will produce. The is a return that 10% every year. Suppose the bond yields a 12% annual interest. It for this reason generates interest revenue of $1,200 every year, sufficient to salary the $1,000 in heating bills and also have $200 left over. In ~ an interest rate of 12%, the link is the far better purchase. If, however, the interest price on bonds were 8%, climate the solar energy system would certainly yield a greater income 보다 the bond. At attention rates listed below 10%, you will invest in the solar power system. At attention rates over 10%, you will certainly buy a bond instead. At an interest rate of exactly 10%, the is a toss-up.

If you carry out not have the $10,000 top top hand and also would need to borrow the money to purchase the solar power system, the interest rate still governs her decision. At attention rates listed below 10%, it renders sense to borrow the money and also invest in the system. At interest rates over 10%, that does not.

In effect, the interest price represents the opportunity price of putting funds right into the solar power system fairly than right into a bond. The expense of placing the $10,000 right into the device is the interest you would certainly forgo by no purchasing the bond.

At any kind of one time, countless investment choices hinge top top the attention rate. Every decision to invest will make sense at some interest rates but not at others. The higher the attention rate, the under potential investments will be justified; the lower the attention rate, the better the number that will certainly be justified. There is thus a an unfavorable relationship in between the attention rate and also the level the investment.

Figure 14.7 "The Investment need Curve" shows an investment demand curveA curve that mirrors the quantity of investment demanded at each interest rate, v all other factors of invest unchanged. For the economy—a curve that reflects the quantity of investment demanded in ~ each attention rate, through all other components of invest unchanged. In ~ an interest rate of 8%, the level of invest is $950 billion per year at point A. At a lower interest price of 6%, the investment need curve shows that the quantity of invest demanded will increase to $1,000 billion per year at suggest B. A reduction in the interest price thus causes a movement along the investment need curve.

Figure 14.7 The Investment demand Curve


The investment need curve shows the volume of investment spending per year at each attention rate, assuming all other determinants of investment space unchanged. The curve mirrors that as the interest price falls, the level of invest per year rises. A reduction in the interest rate from 8% come 6%, because that example, would increase investment native $950 exchange rate to $1,000 billion every year, every other determinants of investment unchanged.

Heads Up!

To make sense of the relationship between interest rates and also investment, you have to remember that invest is an enhancement to capital, and also that funding is miscellaneous that has actually been developed in order to develop other goods and services. A shortcut is not capital. The acquisition of a shortcut is no an investment. We deserve to thus think of purchasing bonds as a financial investment—that is, together an alternate to investment. The an ext attractive bonds are (i.e., the higher their interest rate), the much less attractive investment becomes. If us forget that investment is an addition to the capital stock and also that the acquisition of a link is no investment, us can loss into the complying with kind of error: “Higher interest rates average a higher return top top bonds, so much more people will purchase them. Higher interest rates will therefore lead to better investment.” that is a mistake, of course, since the purchase of a shortcut is not an investment. Greater interest rates rise the opportunity price of making use of funds because that investment. They minimize investment.

Other determinants of invest Demand

Perhaps the most vital characteristic that the investment need curve is no its an adverse slope, however rather the fact that it shifts often. Return investment certainly responds to transforms in interest rates, alters in various other factors appear to pat a an ext important role in driving invest choices.

This section examines eight added determinants of invest demand: expectations, the level of financial activity, the stock of capital, volume utilization, the expense of capital goods, other factor costs, technical change, and also public policy. A change in any of these can shift the investment need curve.


A adjust in the funding stock alters future manufacturing capacity. Therefore, plans to change the resources stock depend crucially on expectations. A for sure considers most likely future sales; a college student weighs future in different occupations and their compelled educational and also training levels. Together expectations readjust in a way that increases the meant return from investment, the investment need curve shifts to the right. Similarly, expectations of diminished profitability change the investment need curve to the left.

The Level of financial Activity

Firms need funding to produce goods and also services. Boost in the level of production is most likely to an increase demand for capital and thus command to better investment. Therefore, rise in GDP is most likely to shift the investment need curve to the right.

To the degree that rise in GDP boosts investment, the multiplier impact of one initial change in one or more components of aggregate demand will be enhanced. Us have currently seen that the rise in manufacturing that occurs with an initial rise in accumulation demand will increase family members incomes, which will boost consumption, thus creating a more increase in accumulation demand. If the increase likewise induces this firm to rise their investment, this multiplier result will be even stronger.

The stock of Capital

The amount of capital currently in use affects the level of invest in 2 ways. First, since most investment replaces resources that has depreciated, a greater resources stock is likely to lead to much more investment; there will certainly be an ext capital come replace. But second, a greater resources stock can tend to reduce investment. The is because investment occurs to readjust the stock of funding to its preferred level. Given that desired level, the quantity of investment essential to reach it will certainly be reduced when the current funding stock is higher.

Suppose, because that example, that genuine estate analysts expect that 100,000 residences will be needed in a particular community through 2010. That will develop a boom in construction—and for this reason in investment—if the current variety of houses is 50,000. Yet it will produce hardly a ripple if there are now 99,980 homes.

How will these conflicting impacts of a larger funding stock kind themselves out? due to the fact that most invest occurs to replace existing capital, a larger capital stock is likely to rise investment. Yet that larger capital stock will definitely act to mitigate net investment. The more capital already in place, the less brand-new capital will be forced to with a given level of funding that may be desired.

Capacity Utilization

The capacity utilization rateA measure of the portion of the capital stock in use. Actions the portion of the capital stock in use. Since capital usually requires downtime because that maintenance and also repairs, the measured volume utilization rate typically falls below 100%. For example, the average production capacity utilization price was 79.7% because that the period from 1972 to 2007. In November 2008 the stood in ~ 72.3.

If a big percentage that the current funding stock is being utilized, this firm are much more likely to rise investment 보다 they would if a large percentage that the capital stock to be sitting idle. Throughout recessions, the volume utilization rate tends to fall. The truth that firms have much more idle volume then depresses investment also further. During expansions, as the volume utilization rate rises, firms wanting to produce more often must rise investment to do so.

The price of capital Goods

The need curve for investment reflects the amount of investment at each interest rate, all various other things unchanged. A readjust in a change held consistent in drawing this curve move the curve. One of those variables is the expense of funding goods themselves. If, because that example, the building and construction cost of new buildings rises, climate the quantity of investment at any kind of interest rate is most likely to fall. The investment need curve for this reason shifts come the left.

The $10,000 price of the solar energy system in the instance given earlier definitely affects a decision to acquisition it. We saw that buying the system makes feeling at attention rates below 10% and does not make sense at interest rates above 10%. If the system expenses $5,000, climate the interest return on the investment would be 20% (the annual saving of $1,000 split by the $5,000 early cost), and also the investment would be undertaken at any interest rate below 20%.

Other element Costs

Firms have actually a range of options concerning how certain goods deserve to be produced. A factory, because that example, could use a advanced capital facility and relatively couple of workers, or it might use much more workers and reasonably less capital. The choice to use funding will be influenced by the price of the resources goods and also the interest rate, but it will likewise be impacted by the expense of labor. Together labor expenses rise, the demand for funding is most likely to increase.

Our solar energy collector example suggests that energy prices influence the demand for resources as well. The presumption that the device would save $1,000 per year in energy expenses must have been based on the prices of fuel oil, organic gas, and electricity. If these prices to be higher, the savings indigenous the solar power system would certainly be greater, enhancing the demand for this form of capital.

Technological Change

The implementation of new technology often requires new capital. Transforms in modern technology can hence increase the demand for capital. Breakthroughs in computer modern technology have urged massive invest in computers. The advancement of fiber-optic modern technology for transmitting signals has actually stimulated vast investments by telephone and also cable tv companies.

Public Policy

Public policy deserve to have significant effects on the demand for capital. Such policies commonly seek to impact the expense of capital to firms. The Kennedy management introduced 2 such tactics in the early on 1960s. One strategy, increased depreciation, enabled firms to depreciate capital assets over a really short period of time. They can report artificially high production costs in the very first years of one asset’s life and thus report lower profits and also pay lower taxes. Sped up depreciation did not readjust the actual price at i m sorry assets depreciated, that course, however it reduced tax payments during the at an early stage years the the assets’ use and also thus reduced the price of hold capital.

The 2nd strategy was the investment taxes credit, which permitted a certain to mitigate its tax liability by a portion of its investment throughout a period. A certain acquiring new capital can subtract a fraction of that is cost—10% under the Kennedy administration’s plan—from the taxes it owed the government. In effect, the government “paid” 10% that the cost of any new capital; the investment tax credit thus reduced the price of resources for firms.

Though much less direct, a third strategy for stimulating investment would certainly be a reduction in taxes on corporate profits (called the corporate earnings tax). Greater after-tax profits median that firms have the right to retain a greater portion of any type of return on one investment.

A 4th measure to encourage greater capital buildup is a funding gains tax rate that permits gains on legacy held during a certain duration to be taxed at a different rate than other income. When an heritage such together a building is marketed for an ext than its acquisition price, the seller that the asset is said to have realized a capital gain. Together a gain can be taxed as revenue under the personal income tax. Alternatively, it can be taxed at a lower rate reserved exclusively for together gains. A lower funding gains tax rate makes assets topic to the tax much more attractive. It hence increases the demand for capital. Congress decreased the capital gains tax price from 28% to 20% in 1996 and also reduced the forced holding duration in 1998. The Jobs and Growth taxation Relief Reconciliation action of 2003 lessened the resources gains tax additional to 15% and likewise reduced the tax rate on dividend from 38% come 15%. A proposal to eliminate capital gains tax for smaller sized firms to be considered yet dropped prior to the stimulus bill of 2009 to be enacted.

Accelerated depreciation, the investment tax credit, and also lower counting on corporate profits and capital benefit all rise the demand for personal physical capital. Public policy can also influence the requirements for other develops of capital. The federal federal government subsidizes state and also local government production that transportation, education, and many other infrastructure to encourage higher investment in public ar capital. Because that example, the federal federal government pays 90% of the cost of invest by local federal government in new buses because that public transportation.

Key Takeaways

The amount of investment demanded in any period is negatively regarded the attention rate. This relationship is illustrated by the investment demand curve. A adjust in the interest rate reasons a movement along the investment need curve. A adjust in any kind of other determinant that investment reasons a change of the curve. The other factors of investment include expectations, the level of economic activity, the stock of capital, the capacity utilization rate, the cost of resources goods, other element costs, technological change, and public policy.

Try It!

Show just how the investment need curve would be influenced by each of the following:

A sharp rise in taxes on revenues earned by firms boost in the minimum wage The expectation that there will be a sharp upsurge in the level of economic activity An boost in the price of new capital goods an increase in attention rates boost in the level of economic activity A herbal disaster that destroys a far-reaching fraction the the funding stock

Figure 14.8


The U.S. Economic situation was widening in 2004, yet there to be a emotion that it still was no functioning as well as it could, together job growth was fairly sluggish. To shot to spur growth, Congress, sustained by chairman Bush, passed a law in 2004 referred to as the American Jobs development Act that gave businesses a one-year special tax break on any kind of profits accumulating overseas that were moved to the united States. Such revenues are called repatriated profits and also were approximated at the time to be about $800 billion. For 2005, the tax price on repatriated profits basically fell from 25% come 5.25%.

Did the taxes break have the preferred effect top top the economy? to some degree yes, though business also found other uses for the repatriated funds. There to be 843 providers that repatriated $312 billion the qualified for the taxation break. The Act therefore generated about $18 exchange rate in tax revenue, a higher level than had actually been expected. Some carriers announced they to be repatriating profits and continuing come downsize. Because that example, Colgate-Palmolive brought back $800 million and made recognized it to be closing a third of that factories and also eliminating 12% the its workforce. However, various other companies’ to plan seemed an ext in line with the objectives of the special taxation break—to create jobs and spur investment.

For example, spokesman chuck Mulloy that Intel, i m sorry repatriated over $6 billion, said the firm was building a $3-billion wafer fabrication facility and also spending $345 million on widening existing facilities. “I can not say dollar-for-dollar exactly how much the the funding for those comes from off-shore cash,” yet he felt that the repatriated funds were contributing to Intel’s as whole investments. Spokeswoman Margaret Graham the Bausch and Lomb, which makes eye-care products and repatriated $805 million, said, “We arrangement to usage that cash for resources expenditures, investment in research and also development, and also paying nonofficer compensation.”

Analysts are skeptical, though, the the repatriated profits really contributed to investment. The New York Times reported on one research that suggested it had actually not. Rather, the repatriated funds were provided for various other purposes, such as stock repurchases. The debate is the the providers made investments the they to be planning to make and the repatriated funds essentially freed up capital for other purposes.

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

Answers to shot It! Problems

The investment demand curve shifts to the left: panel (b). A higher minimum wage provides labor an ext expensive. That company are likely to change to better use of capital, so the investment demand curve move to the right: dashboard (a). The investment need curve move to the right: panel (a). The investment need curve shifts to the left: panel (b). Rise in attention rates reasons a movement along the investment demand curve: panel (c). The investment demand curve shifts to the right: dashboard (a). The must replace capital shifts the investment demand curve come the right: dashboard (a).