Question

What are the neoclassical theory of investment and its policy implications?

Answer 1

Neoclassical theory of investment

It refers to the amount of capital stock that a business desire to obtain at a particular period of time. Capital stock refers to the assets that are to be used for production, for example, plant or equipment. The theory also states how the business will determine its rate of investment by analyzing its speed to adjust the capital stock and achieve the desired level.

Policy implication

• Expansionary fiscal policy combined with a higher investment tax credit to encourage investment.
• Where investment tax credit is a form of subsidy on investment that can decrease the rental cost of capital. And the rental cost of capital is the rate of interest on the funds borrowed for the purpose of investment by the businessmen.
• This combination enables that there is no crowding-out effect with the implementation of expansionary fiscal policy. Crowding out of investment takes place when there is an increase in government spending and low personal tax policy.
• It also results in the increase in the income and the output of firms through which the firms can obtain their desired level of capital stock.
• The theory also recommends using expansionary monetary policy. This will reduce the rental cost of capital and the desired capital stock will increase. Thus, it helps in promoting the necessary investments.