Income and Expenditure - Investment Spending - The Interest Rate and Investment Spending

4 important questions on Income and Expenditure - Investment Spending - The Interest Rate and Investment Spending

What is the relationship between planned investment and interest rate?

  • The higher the interest rate the less firms are going to plan to invest so there will be a low level of planned investment.
  • which means there is a negative relationship between interest rate and planned investment.

When is the onliy time firms will go ahead with investment spending to projects?

  • If  those projects will give them a higher rate of return than the cost of the funds they would need to borrow to finance that project.
  • so when the interest rate rises, fewer projects will have a higher rate of return so the investment will decrease.

What is the profit received from previous investments? What is the opportunity cost of using that profit to finance other projects?

  • Profits received from previous investments are called retained earnings.
  • the opportunity cost of using retained earning, is the interest forgone from being able to lend the funds, and earning interest on them
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Is there a difference between borrowing for a new investment project and using previous retained earnings to fund a project?

Even when there is an increase in interest rate borrowing funds to finance a project, and using retained earnings have the opportunity cost. A rise in the market interest rate is going to make a project less profitable regardless.

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