Econ 2133 1st Edition Lecture 7 Current Lecture A Determinants of Investment 1 Technology In business and new technology comes along that makes producing cheaper must invest in this technology and adapt in order to remain competitive 2 Expectations of the Business Cycle Firm s invest because they can make a buck If economy is forecasted to expand then invest If economic is forecasted to not expand then they won t NEED to believe that economy is going to expand vigorously Because why bother spend the money for no promised income in the future 3 Capacity Utilization Percentage of firm s PPC is in use 45 was in Great Depression 4 Interest Rates Cost of Borrowed Funds In order to invest go to bank and borrow money or float bonds on market cost of this is the interest rate 1 of corporate income earnings it has 4 destinations a Taxation pay taxes on the dollar govt gets first cut If less of the money flows to taxation then the after tax rate of return on capital increases and therefore invest does also b Bond Holders Creditors people that get paid interest Stock holders get more money time BUT bond holders get paid off sooner in case of liquidation of assets for that lower rate of return c Retained Earnings cash balances etc d Stock Holders earn the firm equity holders get paid dividends at the end Residual claimants if there s anything left over then they get this too However last to get paid during liquidation If more bond holders are getting less than stock holders then increase rate of return of capital and investment will increase Inverse relationship between interest rates and investment rates 5 Taxation A EX 1 If we could cut corporate taxes MORE MONEY WOULD FLOW TO SHAREHOLDERS BECAUSE AFTER TAX RETURN ON CAPITAL INCREASES 1 Taxes we have highest corporate taxes in world remember corporate income is double taxed 2 Bond holders 3 Net earnings 4 Share Holders to them would rise and increase investment Flows change stocks These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute B 2 if we could increase corporate taxes LESS MONEY WOULD FLOW TO SHAREHOLDERS BECAUSE AFTER TAX RETURN ON CAPITAL DECREASES 1 Taxes ALWAYS reduce economic activity 2 Bond Holders 3 Net Earnings 4 Share Holders to them would fall and therefore decrease investment 6 Energy Shocks An increase in the relative price of energy oil never good for economic Almost every time in history when this price rises it sends US into recession Price of oil consumer price index relative price of oil If oil goes up by 400 CPI increases by 8 then relative price of oil rises sharply What happened in OPEC Recession of 1973 1975 when price of oil quadrupled overnight Capital is expensive with rising energy costs Aug 1990 oil spike causes recession Price of gas 4 07 gallon before Great Recession in 2007 2009 due to steep relative oil price 7 Bubbles Irrational detachments of asset values from the principles of fundamental valuation a Psychological get people to go crazy via herd mentality one goes off cliff and they all follow EX Internet rise and fall of late 1990s must get on internet stocks they are wave of future told all the old ways of evaluating assets is outdated we have new ones and this time is different when it never is different b Credit Driven EX Housing prices went way up because anybody could get a loan for a house until this bubble popped in our faces It s going to happen again something very similar to the 2008 recession and bubble pops B Fiscal Policy C I G GDP C I private sector of households and firms doing their thing G public sector of government spending Uses of funds a Good Services roads bridges defense oriented goods books for library of Congress b Entitlements Social Welfare State c Investment in National Debt Pay 3 99 Trillion on our annual budget for 2015 Projected deficit of 470 Billion money we are spending above what we are collecting in taxes Congress President creating fiscal policy that uses taxation and spending that actively counter cyclically stabilizes the Business Cycle C I private sector and where taxation has impact by altering consumption and investment G public sector by way of govt spending so if govt spending goes up then that alters GDP Try to reduce periodicity and amplitude of BC fluctuations so move in opposite direction of BC to stabilize it via fiscal policy Forms of fiscal policy a Expansionary when you have recessions or economic slowdowns During recessions economy is slowing down hit the gas by I Cut taxes to increase household disposable income and increase consumption to stimulate economy II Cut taxes to corporations to increase return on capital and thereby increase investment III Increase government spending aka buy stuff ARRA in 2010 aka Stimulus Bill for 834 Billion b Contractionary if you have inflations or debt crises EX Greece in debt crisis pickle because they owe lots of to members of EU What Greece had to do I Cut Government spending II Increase taxes because deficits were too high and no one would loan Greece more money Austerity cut govt spending and raise taxes in general 1 Government Budgeting Government Expenditures uses od funds VS Tax Revenues sources of funds a When Uses Sources Fed Govt has a balanced budget b When Uses Sources almost always the case Fed Govt has a federal budget deficit Federal Govt MUST borrow money c When Uses Sources Fed Govt has federal budget surplus Happened in fiscal years Oct 1st thru Sept 30th 1998 1999 and 2000 part of longest period of economic expansions we have ever had in history While NC s fiscal year is July 1st thru June 30th Deficits mean Govt does not have sufficient to pay for all spending MUST borrow and go into debt Deficit flow variable in fiscal year National Debt sum total stock of what s owed over all time Economic Implications 475 Billion Debt