ECON 1113 1st Edition Lecture 21 Outline of Last Lecture I Investment Spending I A A Definition B Investment Spending and the Business Cycle C Three Types of Investment D Business Fixed Investment IBF Model E The Expected Rate of Return vs Interest Rate i Outline of Current Lecture I The Interest Elasticity of Investment II The Monetary Sector and Investment III A More Complete Keynesian Model Current Lecture I The Interest Elasticity of Investment A A measure of how responsive investors buyers of new capital are to interest rate changes B Interest Elasticity of Investment Coefficient EI percentage change in investment spending percentage change in interest rates iI 1 The answer will always be negative mathematically but take the absolute value C Three Possibilities 1 EI 1 elastic responsive investment demand a Implies that I i 2 b Example if i 1 and I 2 then 2 1 2 EI 1 inelastic unresponsive investment demand a Implies that I i 5 b Example if i 1 and I 2 then 1 5 3 EI 1 unitary elastic D Graphical Interpretations 1 Possibility 1 EI 1 elastic spending 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 II III a Horizontal axis investment spending I in dollars which is dollars spent on new capital goods b Vertical axis interest rate i in percent c The marginal efficiency of investment MEI curve is relatively flat so that when interest rates decrease the investment spending increases much d The change in I or delta I I 1 2 Possibility 2 EI 1 inelastic spending a Horizontal and vertical axes remain the same b The MEI curve is relatively steeper so that when interest rates decrease the investment spending increases less so c The change in I or delta I I 1 The Monetary Sector and Investment A Involves bond money and investment markets now 1 Bond market diagram a Horizontal axis quantity of bonds time b Vertical axis price of bonds in dollars bond c Common supply and demand curves are present d The equilibrium bond price implies the equilibrium interest rate 2 Money market diagram a Horizontal axis quantity of money time b Vertical axis interest rate i in percent c A money demand MD curve mimics a normal demand curve and a vertical money supply MS curve is also present d The equilibrium interest rate implies the equilibrium bon price 3 Investment market diagram a Just like the above descriptions with a negative sloping MEI b The equilibrium interest rate equates to the money market equilibrium interest rate A More Complete Keynesian Model A Horizontal axis nominal GDP Y or actual spending in dollars B Vertical axis planned total expenditure PTE in dollars C A 45 degree Keynesian aggregate supply line begins at the origin and moves outward D A PTE line displays a less steep curve that equals C I G X M E If in this diagram Ye the equilibrium value is less than Y the target value Ye Y it implies unemployment 1 To combat unemployment policy makers could undertake policies to change PTE with an increase initiated through increasing government spending G or decreasing taxation T which specifically increases C these are known as fiscal policies 2 Alternatively a monetary policy meaning a change in the money supply controlled by the Fed can help 3 Through increasing the money supply by either legal reserve requirements discount rates and most importantly open market operations of buying bonds in this instance bond demand increases so bond price increases and interest rates decrease 4 If interest rate i decreases investment spending I increases but by how much depends on the interest elasticity of investment coefficient E I
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