Economics 122. Investment Fall 2012. NOAA’s weather supercomputer. PET Scan of PIB molecule. The Macroeconomics of Investment. Capital Produced, durable, used for further production Examples: tangibles (structures, equipment) intangibles (software, human capital)
NOAA’s weather supercomputer
PET Scan of PIB molecule
Basic role of investment in macro
National accounts include only a small part of “investment-like” spending: 12% of 40%.
Note on data: Very convenient place is “FRED”: http://research.stlouisfed.org/fred2
This is only gross domestic private investment.
1. Accelerator theory: states that investment is a function of change in output
2. Neoclassical theory: Desired capital stock a function of output and cost of capital
3. Q theory: Investment a function of Tobin’s Q (Q =ratio of market value of K to replacement cost)
I* = ΔK* + δK = v Δ Y + δK
The mainstream theory is the neoclassical model.
- This is closely related to the accelerator model.
- The difference is that in the neoclassical model there is a variable capital-output ratio
- Hence, K/Y depends upon relative factor prices, and in particular upon the user cost of capital and taxes.
Using standard production theory
Start with aggregate production function:Y = F(K,L)
Next figure shows the difference of the accelerator and neoclassical models for an isoquant.
Isoquants with fixed capital “investment-like” spending: 12% of 40%.
output ratio v.
fixed K/L ratio in accelerator
Cobb-Douglas in neoclassical
- fixed K/L corresponds to accelerator model
- variable proportions (such as Cobb-Douglas)
corresponds to neoclassical model
uc ≈ (1+τ) pK [r + δ]
whereu = user cost of capitalpK = price of capital goodr = real interest rateδ = depreciation rateτ = effective rate of tax (or subsidy when negative) on capital goods
Linkage to policy:- through real interest rate- through taxation of capital
In practice, u is complicated to measure; off to B School!
when pK = pK (1- δ)/(1+r) + u20,000 = 18,000/(1.05) + uuc = 20,000 – 18,000/1.05 = 20,000 – 17,143 = 2857 ≈ pK (r+ δ) = 20,000(.15) = 3,000
This is a slightly more realistic version that has both debt and equity capital.
Housing price crash
A glut of cargo ships in 2009 powerful but depends importantly on the lifetime of the capital:
More formally: powerful but depends importantly on the lifetime of the capital:
Q = (market value of K)/(replacement cost of K)
- Cargo ships are selling for a Q of 0.25
- E.g., cost of production is $20 million, but ships sell for $5 million
- How is this possible?
How does Q affect investment?
- Because Q < 1, shipping firms buy old ships rather than build new ones
- This depresses investment.
- Therefore I/K = f(Q), f’(Q) > 0.
Idea here is that investment is determined by relationship between the value of firms or houses and the cost of new or replacement capital.
“The daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and another, inevitably exert a decisive influence on the rate of current investment. For there is no sense in building up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit.”
"It is common sense that the incentive to make new capital investments is high when the securities giving title to their future earnings can be sold for more than the investments cost, i.e., when q exceeds one."
Investment and Q powerful but depends importantly on the lifetime of the capital:
I/K = f (Q)
1.. The major components of investment are residential, business plant and equipment, software, and inventories.
2. These are among the most volatile components of output in the short run.
3. In equilibrium, demand for capital determined where the cost of capital equals the marginal productivity of capital.
4. The major theories are the accelerator theory, the neoclassical theory, and the Q theory. These apply differently in different sectors.
5. Economic policy affects investment through both monetary and fiscal policy: