Unit 3: Interest Rates and Investment Demand

Investment: Money spend or expenditures on things like new plants (factories), capital equipment (machinery), technology (hardware + software), new homes, and inventories (goods sold by producers)

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Expected Rates of Return

How do businesses make investment decisions? 
- Cost / Benefit Analysis

How does business determine the benefits? 
- The expected rate of return

How does business count the cost? 
- Interest costs

How does business determine the amount of investment they undertake? 
- Compare the expected rate of return to interest cost
- If expected return > interest cost. then invest
- If expected return < interest cost, then do not

Real vs. Nominal Interest Rate

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What's the difference? 
- Nominal is the observable rate of interest while real subtracts out inflation (π%) and is only known x post facto.

Formula: r% = i% - π%

What determines the cost of an investment decision?
- The real interest rate (r%)

Investment Demand Curve

What is the shape of the investment demand curve?
- Downward sloping

Why? 
- 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 interest rates of return, and many that yield low rates of return

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