ECON 1113 1st Edition Lecture 21 Outline of Last Lecture I. Investment Spending (I)A. A DefinitionB. Investment Spending and the Business CycleC. Three Types of InvestmentD. Business Fixed Investment (IBF) ModelE. The Expected Rate of Return (ρ) vs. Interest Rate (i)Outline of Current Lecture I. The Interest Elasticity of InvestmentII. The Monetary Sector and InvestmentIII. A More Complete Keynesian ModelCurrent LectureI. The Interest Elasticity of InvestmentA. A measure of how responsive investors (buyers of new capital) are to interest rate changesB. Interest Elasticity of Investment Coefficient (EI) = percentage change in investment spending/percentage change in interest rates = |% ∆ I% ∆ i|1. The answer will always be negative mathematically, but take the absolute valueC. Three Possibilities1. EI > 1: elastic (responsive) investment demanda. Implies that % ∆ I >% ∆ ib. Example: if % ∆i = -1%, and % ∆ I = +2%, then |+2−1| = 22. EI < 1: inelastic (unresponsive) investment demanda. Implies that % ∆ I <% ∆ ib. Example: if % ∆i = -1%, and % ∆ I = +2%, then |+.5−1| = .53. EI = 1: unitary elasticD. Graphical Interpretations1. 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.a. Horizontal axis: investment spending (I) in dollars, which is dollars spent on new capital goodsb. Vertical axis: interest rate (i) in percentc. The marginal efficiency of investment (MEI) curve is relatively flat so that when interest rates decrease, the investment spending increases muchd. The change in I or delta I = % ∆ I > 12. Possibility 2: EI < 1 (inelastic spending)a. Horizontal and vertical axes remain the sameb. The MEI curve is relatively steeper so that when interest rates decrease, the investment spending increases less soc. The change in I or delta I = % ∆ I < 1II. The Monetary Sector and InvestmentA. Involves bond, money, and investment markets now1. Bond market diagrama. Horizontal axis: quantity of bonds/timeb. Vertical axis: price of bonds in dollars/bondc. Common supply and demand curves are presentd. The equilibrium bond price implies the equilibrium interest rate2. Money market diagrama. Horizontal axis: quantity of money/timeb. Vertical axis: interest rate (i) in percentc. A money demand (MD) curve mimics a normal demand curve, and a vertical money supply (MS) curve is also presentd. The equilibrium interest rate implies the equilibrium bon price3. Investment market diagrama. Just like the above descriptions with a negative sloping MEIb. The equilibrium interest rate equates to the money market equilibrium interest rateIII. A More Complete Keynesian ModelA. Horizontal axis: nominal GDP (Y) or actual spending in dollarsB. Vertical axis: planned total expenditure (PTE) in dollarsC. A 45 degree Keynesian aggregate supply line begins at the origin and moves outwardD. 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 unemployment1. 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 policies2. Alternatively, a monetary policy, meaning a change in the money supply controlled by the Fed can help3. 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 decrease4. If interest rate (i) decreases, investment spending (I) increases, but by how much depends on the interest elasticity of investment coefficient