Investment

• What are the components of Tobin's q?

  • Numerator: stock market value of the economy’s capital stock
  • Denominator: actual cost to replace the capital goods purchased when stock was issued
• What happens if Tobin's $q$ is greater than 1?


  Firms buy more capital to raise the market value of their firms.
• What happens if Tobin's $q$ is less than 1?


  Firms do not replace capital as it wears out.
• What factors cause a change in investment according to both the optimal capital stock model and the Tobin's q model?

  Investment is likely to rise if productivity or output prices rise, or the interest rate falls.
• How does a fall in the cost of capital affect investment?

  It encourages investment.
• What is the main feature added by the Tobin's q model compared to the optimal capital stock model?

  • Current investment is influenced by the future values of relevant variables.
• How does a wave of pessimism about future profitability of capital affect the economy?

  • Causes stock prices to fall
  • Causes Tobin's $q$ to fall
  • Shifts the investment function down
  • Causes a negative aggregate demand shock
• What effects does a fall in stock prices have on the economy?

  • Reduces household wealth
  • Shifts the consumption function down
  • Causes a negative aggregate demand shock
• What might a fall in stock prices reflect about the economy?

  Bad news about technological progress and long-run economic growth.
• What implications does a fall in stock prices have for aggregate supply and full-employment output?

  Aggregate supply and full-employment output will be expanding more slowly than expected.
• What does Neoclassical theory assume about firms' ability to borrow capital?

  • Firms can borrow to buy capital whenever doing so is profitable.
• What are financing constraints?

  Limits on the amounts firms can borrow or raise in financial markets.
• How does a recession affect a firm's current profits?

  It reduces current profits.
• When might investment be worthwhile despite low current profits?

  When future profits are expected to be high.
• Why might a firm facing financing constraints not be able to obtain funds?

  Because current profits are low and they cannot borrow to finance investment.
• What does the flow of new residential investment $I_H$ depend on?


  • Relative price of housing $P_H/P$
• How is the relative price of housing $P_H/P$ determined?


  By supply and demand in the market for existing houses.
• What represents the stock of housing capital?

  $K_H$
• What percentage of GDP is inventory investment approximately?

  • About $1$ of GDP.
• How much of the fall in spending during a typical recession is due to a fall in inventory investment?

  More than half of the fall in spending.
• What are the motives for holding inventories?

  • Production smoothing
  • Inventories as a factor of production
  • Samples for retail sales purposes
  • Spare parts for when machines break down
  • Stock-out avoidance
  • Work in progress
  • Relationship to the real interest rate
• Why do firms engage in production smoothing?

  To produce at a steady rate when sales fluctuate.
• What happens to inventories when sales are less than production?

  Inventories rise.
• How do inventories act as a factor of production?

  Inventories allow some firms to operate more efficiently.
• What happens to inventories when sales are greater than production?

  Inventories fall.
• Why do firms hold samples for retail sales purposes in their inventories?

  To showcase products to customers.
• What are spare parts used for in inventories?

  To replace broken-down machine parts.
• What is the purpose of stock-out avoidance in inventory management?

  To prevent lost sales in the event of higher-than-expected demand.
• What are goods not yet completed called in inventory terms?

  Work in progress.
• How does the real interest rate affect inventories?

  It influences the optimal inventory level based on the cost of holding inventories.
• What theories were covered in this lecture on investment behaviour?

  • Business investment
  • Residential investment
  • Inventory investment
• What percentage of GDP is attributed to Personal consumption expenditures in the USA in 2018?

  68.0%
• What was the gross domestic product (GDP) of the USA in 2018?

  $20580
• What is the formula for the Cobb-Douglas production function?

  • $Y =$$A K^\alpha L^{1-\alpha}$
  • $\alpha$ represents the output elasticity of capital
  • $A$ denotes total factor productivity
  • $Y$ denotes output
  • $K$ is capital input
  • $L$ is labour input
• In the Cobb-Douglas production function, what does $\alpha$ represent?


  The output elasticity of capital
• In the Cobb-Douglas production function, what does $A$ represent?


  Total factor productivity
• What is the law of diminishing returns in the Cobb-Douglas production function?

  • An increase in capital decreases the marginal product of capital.
  • An increase in capital increases output at a diminishing rate.
• What are the two types of firms assumed in the standard model of business fixed investment?

  Production firms and rental firms
• In the context of the neoclassical model of investment, how do production firms behave?

  They rent the capital they use to produce goods and services.
• In the neoclassical model of investment, how do rental firms behave?

  They own capital and rent it to production firms.