MGEB06H3 Lecture Notes - Lecture 5: Inventory Investment

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Macroeconomics Notes: Lecture Five (Chapter Eleven) PART2:
Investment Spending
ā€¢ Investment is the most unstable component in GDP.
ā€¢ The equation is actual investment consists of planned investment and unplanned investment.
ā€¢ IActual = IPlanned + IUnplanned
Planned Investment:
ā€¢ Planned investment (IPlanned) is the level of investment that firms plan to use during a given
period.
Factors that affect planned investment:
1. Interest Rate
ā€¢ an increase in interest rate raises the cost of investment ļƒž planned investment falls.
ā€¢ Planned investment is inversely related to the interest rate.
2. Expected Future Real GDP
ā€¢ The accelerator principle is an increase in the future real GDP, growth rate leads to an
increase in planned investment because firms now investment more to meet the demand
from higher expected sales due to higher future real GDP.
ā€¢ Planned investment is positively related to the future real GDP growth.
A typical planned investment function:
ā€¢ IPlanned = IPlanned(i)
ā€¢ IPlanned = Autonomous investment (AI) ā€“ dļ‚“i, where d > 0.
Inventories and Unplanned Investment Spending:
ā€¢ Firms hold inventories to avoid trouble in the sales/store.
ā€¢ Inventory investment refers to the change in the value of total inventories during a given
period; the materials and supplies that firms hold in storage
ā€¢ Inventory investment = ļ„Inventories
ā€¢ It is possible for inventory investment to be negative!
ā€¢ If actual sales are greater then expected sales firms have to deplete their inventories in order
to meet higher than expected sales.
ā€¢ it is very difficult to predict future sales; firm may hold more or less inventories than they
desired/planned.
ā€¢ These unexpected changes in inventories are called unplanned inventory investment and
are equal to unplanned investment.
ā€¢ IUnplanned = unplanned inventory investment.
Actual Investment:
ā€¢ Actual investment (IActual or I for short) refers to the level of investment that the economy has
undertaken in a given period of time.
ā€¢ I = IActual = IPlanned + IUnplanned
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