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Investment Interest Rate

The document discusses the relationship between investment and interest rates, highlighting that higher interest rates lead to decreased investment demand due to increased costs of borrowing. It explains how the quantity of investment is influenced by the real interest rate and the responsiveness of investment to changes in interest rates. Additionally, it differentiates between net and gross investment, emphasizing the impact of depreciation on capital stock.

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sheikh mujib
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13 views3 pages

Investment Interest Rate

The document discusses the relationship between investment and interest rates, highlighting that higher interest rates lead to decreased investment demand due to increased costs of borrowing. It explains how the quantity of investment is influenced by the real interest rate and the responsiveness of investment to changes in interest rates. Additionally, it differentiates between net and gross investment, emphasizing the impact of depreciation on capital stock.

Uploaded by

sheikh mujib
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Investment & Interest Rate

Anything added with the capital stock → Investment (I)

The quantity of investment goods demanded (ID )depends on the interest rate (IR )which
​ ​

measures the cost of funds used to finance investment

P rofit = Return − Cost

Revenue from increased future>Payments for borrowed funds → Profitable Investment

IR ↑ ID ↓ I ↓
​ ​

As Ir increases → fewer investment projects become profitable, and the quantity of


​

investment demand falls

As Ir rises → cost of capital increases and Investment falls


​

Interest rate I(r)is a function of the real interest rate (r)which measures the cost
of borrowing and determines the quantity of investment (I)

Investment & Interest Rate 1


High I(r)→ Excess Liquidity

Low I(r)→ Liquitidy Crisis

I = I , when r = 0

h = Slope of investment f n 
I = I − hr
hr = I − I = Responsiveness of investment in real
1 terms to interest
r = (I − I) h =
​

0
h = How much Investment will change per
unit of change in the interest rate

Here I(r)is an inverse function

A smaller h → Steeper Investment Net Investment = Gross Investment -


Demand → Less Responsive to the Depreciation Cost
change of r 
Net Investment > 0 → Capital Stock ↑
A larger h→ Flatter Investment Net Investment = 0 → Capital Stock
Demand → More Responsive to the remains unchanged
change of r 

Investment & Interest Rate 2


Investment & Interest Rate 3

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