What is an Investment?
- Money Spent or Expenditures on:
- New Plants (Factories)
- Capital Equipment (Machinery)
- Technology (Hardware & Software)
- New Homes
- Inventories (Goods Sold by Producers)
- Money Spent or Expenditures on:
- New Plants (Factories)
- Capital Equipment (Machinery)
- Technology (Hardware & Software)
- New Homes
- Inventories (Goods Sold by Producers)
Expected Rates of Return
- How does business make investment decisions?
- Cost/Benefit Analysis
- How does business determine the benefits?
- Expected Rate of Return
- How does business count the cost?
- Interest Costs
- How does business determine the amount of investment they undertake?
- Compare Expected Rate of Return to Interest Cost
- If Expected Return > Interest Cost; Invest
- If Expected Return < Interest Cost; Do NOT Invest
Nominal ( i % ) - Observable Rate of Interest
Real ( r % ) - Subtracts out Inflation and is known as post-facto
Real Interest Rate ( r % = i % - π % )
What determines the cost of an investment decision? The Real Interest Rate (r%)
- When interest rates are high; fewer investments are profitable, vice versa.
- Conversely, there are few investments that yield high rates of return, and many that yield low rates of return
- How does business make investment decisions?
- Cost/Benefit Analysis
- How does business determine the benefits?
- Expected Rate of Return
- How does business count the cost?
- Interest Costs
- How does business determine the amount of investment they undertake?
- Compare Expected Rate of Return to Interest Cost
- If Expected Return > Interest Cost; Invest
- If Expected Return < Interest Cost; Do NOT Invest
- When interest rates are high; fewer investments are profitable, vice versa.
- Conversely, there are few investments that yield high rates of return, and many that yield low rates of return
I would add that people are hesitant to invest when interest rates are higher but more confident about investing when interest rates are lower! People want the most out of their buck.
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