1. The Investment Schedule. Suppose there is a firm that is considering whether to build a new factory. The factory will cost $100 to construct today, and will yield revenue of $110 a year from now. (For simplicity, we will assume the factory yields no further returns in future years).
- What is the return on capital from constructing the factory?
- Will the firm build the factory if the interest rate is 7%? If it is 12%? Explain.
- Now suppose that instead of one firm, there are many firms that are considering whether to build a factory, each of which costs $100 to construct. The first factory will yield rev- enue of $120, the second revenue of $119, the third $118, and so on, decreasing by $1 for each additional factory built.
- Use the numbers above to draw the investment demand schedule for the economy.
- Suppose that the interest rate is 7%. What will be the level of investment in the econ- omy? (Note: you may assume that firms will build factories that just break even.)
- Now suppose that people become more optimistic about the future, and believe that factories will yield revenue $3 higher than they previously thought. Show what hap- pens to the investment demand schedule, and compute investment at the given 7% interest rate.
- Now suppose that expectations are at their previous level, but the interest rate rises to 12%. What happens to investment?