Unit 3- Interest Rates and Investment Demand

Investment

Money spent or expenditures on the following:

• New plants (factories)
• Capital equipment (machinery)
• Technology (hardware and software)
• New homes
• Inventories (goods sold by producers)

Expected Rates of Return

• Businesses make investment decisions using cost/benefit analysis. 
• Businesses determine benefits by determining the expected rate of return. 
• Businesses count the costs by interest costs. 
• Businesses determine the amount of investment they should undertake by comparing the expected rate of return to the interest cost. 
• If the expected return is greater than the interest cost, then they should invest. 
• If the expected rate of return is less than the interest cost, then they shouldn't invest.

Real (r%) v. Nominal (i%)

• The nominal interest rate (i%) is the observable rate of interest.
• Real interest rate (r%) subtracts out the inflation rate (π%) and is only known ex post facto. 
• The real interest rate determines the cost of an investment decision. The equation is as follows: r% = i% - π%

Invest Demand Curve 

• The shape of the investment demand (ID) curve is downward sloping 
• When interest rates are high, fewer investments are profitable
• When interest rates are low, more investments are profitable. 
• Conversely, there are few investments that yield high rates of return and many that yield low rates of return.