Chapter 14 Investment and Economic Activity

1. THE ROLE AND NATURE OF INVESTMENT Learning Objectives Discuss the components of the investment spending category of GDP and distinguish between gross and net investment. Discuss the relationship between consumption, saving, and investment, and explain the relationship using the production possibilities model.

1.1 Components of Investment

1.2 Gross and Net Investment

1.3 Volatility of Investment

1.4 Investment, Consumption and Saving If depreciation equals IA then net investment is zero and PPC does not shift. D CD A CA B By reducing consumption and increasing investment the PPC shifts outward. Allowing more consumption CB PPC2 PPC1 IA IB ID

2. DETERMINANTS OF INVESTMENT Learning Objectives Draw a hypothetical investment demand curve, and explain what it shows about the relationship between investment and the interest rate. Discuss the factors that can cause an investment demand curve to shift.

2.1 Interest Rates and Investment The investment demand curve is a curve that shows the quantity of investment demanded at each interest rate with all other determinant of investment unchanged.

2.2 Other Determinants of Investment Demand Expectations The level of economic activity The stock of capital Capacity utilization The capacity utilization rate is a measure of the percentage of the capital stock in use. The cost of capital goods Other factor costs Technological change Public policy

3. INVESTMENT AND THE ECONOMY Learning Objectives Explain how investment affects aggregate demand. Explain how investment affects economic growth.

3.1 Investment and Aggregate Demand 8 B 6 C D 1.0 ΔI=$50 ΔAD=$100 ID AD1 AD2 $950 $1,000 $8,000 $8,100

3.2 Investment and Economic Growth Investment adds to the capital stock An increase in capital stock leads to an outward shift of the PPC This allows more consumption The long run AS curve also shifts to the right The increase in investment also affects aggregate demand