Unit 3: 02/22/16

Investment Demand

What is Investment?
• money spent on expenditures on...
- new plants (factories)
- capital equipment (machinery)
- technology (hardware and software)
- new homes 
- inventories (goods sold by producers)

Expected rate of returns 
• how does businesses make investment decision? 
Answer: cost and benefit analysis
• how does business determine the benefit?
Answer: expect rate of return (outflows, inflows)
• how does business count the cost?
Answer: interest cost
• how does business determine the amount of investment they undertake?
Answer: compare expected rate of truth to interest cost
• if expected return > interest cost, then you'll invest 
• if expected return < interest cost, the do not invest 

Real (r%) v. Nominal (i%) 
- what is the difference? 

• nominal is the observable rate of interest. ( real subtract out inflation (n%) and is only known. (example: post facto)
How do you compute the real interest rate? 
• r% = i% = pi%

Why then determines the cost an investment decision? 
- interest cost minus the real inherit rate (r%)