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Consider the model of fixed business investment.

(a)  On an r vs. I diagram, sketch a curve showing how investment depends on the real interest rate, based on our "Investment function", In(). Explain the intuition of why investment depends on r.

(b) Show the impact on your diagram of each of the following: (i) A fall in the relative price of capital (ii) An increase in Total Factor Productivity (iii) A destruction of some of the capital stock due to a natural disaster.

(c) Could we readily integrate our investment function In() into our basic ISLM framework? If yes, how? If yes, how would each of the above cases manifest itself on the ISLM diagram?

Macroeconomics, Economics

  • Category:- Macroeconomics
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