Chapter 9
Theory of
Investment
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
Topics to be Discussed
? 9.1 Decision of investment
? 9.2 Investment function
? 9.3 Inventory investment & Investment
in residential structures
9.1 Decision of Investment
? Concept of investment
? Flow of payout that will increase the stock of capital
? Categories of investment,
? Fixed business investment
? Inventory investment
? Investment in residential structures
9.1 Decision of Investment
? Micro basic（ use Fix business investment as an
example）
?Two procedures of investment decision
?Decide desired capital stock；
?Get desired capital stock by investment
9.1 Decision of Investment
? Desired capital stock
? Fixed capital stock that can achieve maximal profit
when added to other production elements
? Principle to decide desired capital stock,
? Principle to decide desired capital stock (ignore
tax）,
Marginal income of capital=price of the capital
9.1 Decision of Investment
? Principle to decide desired capital stock （ take tax into
account）,
? If u=t,tax will not influence investment；
? If u>t,tax will encourage investment；
? If u<t,tax will hinder investment。
MR（ 1-t） =MC（ 1-u）
t is the ratio of tax on profit,u is the favorable term such as tax-cut
MR= [（ 1-u） / （ 1-t） ]MC
9.1 Decision of Investment
? Given Y0,the decision of desired capital stock K*
Rk
MR
MC
Y0
K*
9.1 Decision of Investment
?When output changes,the decision of
desired capital stock
MR
MC
Y0
K*
Y1
K′
Rk
9.1 Decision of Investment
? From all above,desired capital stock will
decided by two elements,
? Price to rent capital Rk
? Planned output Y
? Express by function,
K*=g(Rk,Y)
9.1 Decision of Investment
? Decide price of renting capital,
? Ignore the price change of capital
? Consider the price change of capital
Rk=（ R+d） Pk
Rk=（ R+d） Pk-△ Pk
9.2 Investment Function
? Motive of investment,
? Make up the difference between desired capital stock
K* and the real capital stock of last year K-1
I=K*- K-1= g(Rk,Y) - K-1
I=λ( K*- K-1 ) (0<λ<1)
Consider the lag of
investment
9.2 Investment Function
? Tobin’s q theory（ Tobin,1969）
? If capital is completely durable（ depreciation ratio is
0）,the level of investment is decided by the ratio of
the market value to the replacement cost of
capital,expressed by q；
? Market value of capital expresses the expectation of the
public；
? When q>1,investment will increase； when q<1，
capital should be sold,
9.3 Inventory Investment and
Investment in Residential Structures
? Categories of Inventory investment,
?Material accumulation
?Semi-product accumulation
?Final product accumulation
9.3 Inventory Investment and
Investment in Residential Structures
? Motive for inventory,
? Smooth the produce course
? Avoid being out of stock
? Desired ratio of inventory to sale is due to,
? The development of flow & information industry
? Phase in the economic cycle
9.3 Inventory Investment and
Investment in Residential Structures
? Investment in residential structures is similar
to fixed business investment,the difference is,
? residential structures’ depreciation is difficult to
weight
?The scarcity of land determines that
residential structures investment has some
speculate motives
Chapter 9
The End
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00