Question

How would you expect each of the following developments to affect the investment demand curve? (Recall: the investment demand curve shows the relationship between the interest rate and the quantity of new capital demanded for purchase.)

a. New production procedures to prevent workers from exposure to Covid-19 raise the price of capital goods.

b. Firms become less optimistic about future sales of the output that the capital goods can produce.

c. The Federal Reserve raises interest rates.

d. Technological progress makes each machine able to produce more output than before

Answer 1

Before answering this question, It should be remembered that INVESTMENT means investment in capital goods and not investment in bonds. So there is a NEGATIVE relationship between Interest rates and Investment.

a. Increase in Price of Capital Good means, there is a change in one of the variables that is INVESTMENT, interest rate being the same. This means that quantity of investment at any interest rate will fall shifting the curve to left.

** Please see image for curve.

b. If firm is less optimistic about the future sales, then there will be less investment for the same. This will decrease the investment while interest being same. Hence curve will shift to it's left.

** Refer to the curve as in a. part

c.A change in the interest rate will result in movement along the investment demand curve. Increase in interest rate will decrease Investment as investment becomes less attractive with higher interest rates of other securities. So there wil be UPWARD movement on the same curve.

d. Technological progress means better output which will attract more investment in capital goods. This will shift the curve to its right.