Investment Demand

Investment decisions = marginal analysis.

marginal benefit = expected rate of return
marginal cost = interest rate (paid for borrowed $)

Firms will invest if:
expected rate of return >= interest rate

Rate of Return

• Net expected revenue - cost = profit
• profit / cost = rate of return 

Example 
Nice Tool Manufacturing 
Possible investment: New Okuma CNC Mill
Cost: $100,000
Next Expected Revenue: $110,000
Expected Profit: ? $10,000

Expected RoR:  ?   .1 (10%)

Must also consider the interest rate
interest cost = principal x interest rate (i)
Let's say i = 5%
Interest cost = $5,000
Net Profit (including interest costs) = $5,000


Let's say i = 15%
Interest cost = $15,000
Interest rate > expected RoR
(15% > 10%)

Investment will be undertaken if
expected rate of return (r) => the real interest rate (i)

Investment demand graph. 

• total investment demand in biz. sector (nominal interest)
• Slopes down.
• As interest lowers, demand for investment funds increases. 
• Interest is a cost of doing business. 
• component of GDP (Ig)
• (i = normal interest rate)

Who is demanding this investment (three big ones)

• Businesses
• Mortgages
• Student loans / education

Investment will be undertaken if
expected rate of return (r) => the real interest rate (i)

Shifts of the investment Demand Curve 

1)Cost of acquiring, maintaining, and operating capital goods.  

• When these costs rise, expected RoR shrinks
• Investment demand falls
• ID curve shifts to the left. 
• If these costs lower / curve shifts right

2)business taxes

• firms looks at returns after taxes
• tax hike = lower expected RoR
• lower investment demand / curve shifts left 
• tax cut = higher expected RoR
• higher investment demand / curve shifts right 

3)Technological Changes

• new tech stimulates investment 
• more efficiency lowers production costs
• new tech means new demand 
• rapid increase in technology shifts the curve to the right

4)stock of capital goods on hand

• if an economy is overstocked with capital goods and finished products, expected RoR declines
• investment demand declines.  (what's the point of investing?)
• curve shifts left

• if an economy is understocked with capital and finished goods, 
• firms selling as fast as they can, expected RoR increces
• curve shifts right

5)business expectations

• regulation uncertainty, cost uncertainty, demand uncertainty
• if firms are optimistic about the future
• curve shifts right
• if firms pessimistic
• curve shifts left