Investment be sold in the short run. According

Investment is an important factor of the national economic development in the long run and short run business cycle. During a recession, mostly goods and services expenditure decreases significantly because of the fall of the investment.  The investment term is different from the spending money for consuming. Spending money for the consumptions of goods and services gives us the utility straight away, however, spending money for investment will give us the higher standard of living in the later on. Furthermore, in the neoclassical and exogenous growth model, both count the investment as one of the main factors that can boost the economic growth.

This paper focuses on the explanation of the theories behind of investments function, that is I=I (r). According the IS-LM model, the decrease of the real interest rate will increase the spending money for the investment. Mankiw (2009) categorized the investment spending into three types described below. 1.      Business Fixed Investment (equipment and structures in production)2.      Residential Investment (new housing to live and to rent out)3.      Inventory Investment (goods in storage)Business fixed investment is the goods and services that are bought by the firms for future production in the long term.

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It is different to the inventory goods that will be sold in the short run. According to many economists, the model Cobb-Douglass production function can explained well about how capital and labour turn into goods and services. where, A= parameter of technology, K =Capital and L = Labour. In addition, the factors that influence the cost of the capitals are the interest rate, the price of the capital, the depreciation of the capital and the changing rates of capital prices.

Off course, the profit is the main factor of the determinants to increase and decrease the capital stock, can be seen in the function below. then the investment function, This function shows that the cost of the capital is influenced by the real interest rate. The higher interest rate means the higher capital cost.

So the people tend to reduce to own capital or to reduce the investment. It can be seen in the table 1 (panel a) below. Furthermore, panel b shows that the shift of the investment function because of the increase of marginal product of capital that will increase the profitability of investment such as the new technology invention. Figure 1. The Investment Function  Note. Reprinted from Macroeconomics (7th ed.) by Mankiw, N. G.

, 2009, p. 531. Copyright 2009 by Worth Publishers.  The government policies can also influence the increase or the decrease of the investment through taxes. a.       The corporate income tax (tax on the firm profits)b.

      The investment tax credit (tax cuts to stimulate the investment) Furthermore, the Nobel Prize-winning economist, James Tobin, proposed a new model that is, If the q>1 means that the firms can raise the value of their firm stocks by investing new capital. The increase of q also means investors’ optimism in the current and future profitability of capital. Mankiw also explains why the stock prices are related to the economic condition.

Stock is part of household wealth and the raise of the stock prices reflects the better technological progress and long-run economic growth. Secondly, residential investment is the purchase of the houses by the residents to live in or to rent out. Below is the market of the housing.Figure 2.

Housing Market Note. Reprinted from Macroeconomics (7th ed.) by Mankiw, N.

G., 2009, p. 541. Copyright 2009 by Worth Publishers.   Factors that influence the increase of the demand of the houses are the fall in the real interest rate and population addition. Finally, inventory investment is that the firms’ goods that are in storage that will be sold. Mostly it is the smallest part of the money spending around 1% of the GDP. Several reasons of holding inventories are to adjust the level of production overtime, anticipating the low and high sales, and to achieve the efficient operating.

For example, in the long Christmas holiday, mostly the firms increase the inventories to prevent running out of the goods (stock-out avoidance). Furthermore, the real interest rate also affects the holding of inventories. When the real interest rate is higher, the businessmen tend to decrease the inventories vice versa. The credit condition also influences the inventories because many firms take credits to buy stocks. In sum, the real interest rate significantly influences the investment spending. Higher real interest rate means higher cost of capital or higher cost of borrowing houses.

The advance of technology and the growth of population shift up the investment of homes and capital. In addition, the output of the economy also influences the number of investment. Higher incomes pushes the increase of investment spending.    ReferencesMankiw, N. G. (2009).

Macroeconomics (7th ed.). New York: Worth Publishers.


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