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Intermediate Macroeconomics

4. Intertemporal Investment Decisions

Here we look at the investment decision from the point of view of a profit maximizing producer in a multi-period model that considers the present cost of investment and the return earned in the future. We build on the producers' profit maximization decision from the Production and Labor Market Section to include two periods and an investment decision. Investment is purchases of capital which includes machines, buildings, factories, and any other manufactured good used in the production of goods and services. Understanding the behavior of investment is important for both short-run and long-run macroeconomic considerations. In the short-run, investment is one component of demand for all final goods and services, so fluctuations in investment demand can have consequences for the business cycle. In the long-run, investment leads contributes to a nation's capital stock which influences their long-run production possibilities, and therefore their long-run standard of living.

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Profit Maximization

We begin by building a framework for understanding producers' decisions for maximizing profits in a multi-period environment that includes profits in the present and future. This includes costs for investment purchases incurred in the present, and future revenue for businesses that depends positively on the amount of capital available in the future. [Play Pencast]

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Investment Demand

We drive producers' profit maximizing choice for investment using framework established in the previous Pencast for producers' profits. We find that the demand curve for investment depends negatively on the real interest rate, and illustrate this behavior graphically. [Play Pencast]

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Shift in Investment Demand

Here we look at two possible reasons for a shift in investment demand. First we consider the possibility that there is an increase in the depreciation rate for capital goods. This could be the result of over-using or poorly maintaining capital goods. In this case the profit maximizing decision for the quantity of investment decreases and demand shifts to the left. In another example, we suppose an improvement in technology is announced which will soon be available. An improvement in technology in the future leads to an increase in the future marginal product of capital. The profit maximizing decision for the quantity of investment increases in this scenario, causing a rightward shift in investment demand. [Play Pencast]

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