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Chapter 21: Q4 (page 566)

During and in the aftermath of the financial crisis of 2007鈥�2009, planned investment fell substantially despite significant decreases in the real interest rate.

What factors related to the planned investment function could explain this?

Short Answer

Expert verified

Decrease in Marginal Productivity of capital, Expected profit can lead to fall in investment despite of decrease in interest rate.

Step by step solution

01

Investment Function Basics 

As per classical economists, specially Keynes -

There are three factors effecting Business Investment - Cost (ie Interest), Return determined by Marginal Efficiency (ie Marginal Productivity) of capital, Expectations

02

Detail Explanation 

If Interest rate has fallen, investment expenditure can still decrease due to unfavourable decline other factors - ie Marginal Efficiency (yield) of capital, Expectations

It leads to decrease & leftward shift of inverse investment curve / function, ie primarily dependent on interest.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database, and find data on Personal Consumption Expenditures (PCEC), Personal Consumption Expenditures: Durable Goods (PCDG), Personal Consumption Expenditures: Nondurable Goods (PCND), and Personal Consumption Expenditures: Services (PCESV).

a. Using the most recent data, what percentage of total household expenditures is devoted to the consumption of goods (both durable and nondurable goods)? What percentage is devoted to services?

b. Given these data, which specific component of household expenditures would be most impacted by a reduction in overall household spending? Explain.

Inventories typically increase starting at the beginning of recessions, and begin to decline near the end of recessions. What does this say about the relationship between planned spending and aggregate output over the business cycle?

鈥淔irms will increase production when planned investment is less than (actual) total investment.鈥� Is this statement true, false, or uncertain? Explain your answer.

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.

If a change in the real interest rate has no effect on planned investment spending or net exports, what does this imply about the slope of the IS curve ?
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