MGEA06H3 Lecture Notes - Lecture 5: Inventory Investment, Keynesian Cross

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10 Feb 2016
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Planned Investment
Planned investment (IPlanned) refers to the level of investment that firms
intend to undertake during a given period.
Factors that affect planned investment:
1) Interest Rate
Given the returns on investment are predetermined (chapter 10), an increase
in interest rate raises the cost of investment planned investment falls.
Planned investment is inversely related to the interest rate.
2) Expected Future Real GDP
The accelerator principle suggests an increase in expected future real GDP
growth rate (for a given current level of production capacity) leads to an
increase in planned investment because firms need to undertake more
investment now in order to meet the demand from higher expected sales due
to higher future real GDP.
Planned investment is positively related to the future real GDP growth.
A typical planned investment function:
IPlanned = IPlanned(i)
IPlanned = Autonomous investment (AI) – di, where d > 0.
MGEA06 – Week 5 Iris Au 1
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Inventories and Unplanned Investment Spending
Firms hold inventories to avoid disruption in the production process and to
avoid missing any unforeseen changes in sales.
Inventory investment refers to the change in the value of total inventories
during a given period; it includes quantity of goods (including materials and
supplies) that firms hold in storage, work in process, and finished goods.
Inventory investment = Inventories
Note: It is possible for inventory investment to be negative!
Since it is very difficult to predict future sales accurately, firm may find
themselves hold more or less inventories than they desired/planned.
ÞThese unexpected changes in inventories are called unplanned inventory
investment and are equal to unplanned investment.
IUnplanned = unplanned inventory investment.
Actual Investment
Actual investment (IActual or I for short) refers to the level of investment that
the economy has undertaken in a given period of time.
I = IActual = IPlanned + IUnplanned
I = [AI – di] + IUnplanned
MGEA06 – Week 5 Iris Au 2
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