Business fixed investment:

· Business fixed investment means investment in the machines , tools and the equipments
that business buy for use in the future production of goods and services.

· The stock of these machine or plant equipment etc represent fixed capital.

· The rental price of capital:

· The rental firms rent capital at a rental rate R and sells it output at price P.The real cost of
a unit of capital of the production firm is R /P.

· The real benefit of unit of capital MPK.The extra output produced with one more unit of
capital.

· The MPK declines as the amount of capital rises.

Production function Cobb-Douglas:

· Y= AKᵅ L 1-ᵅ Where Y is output. K is capita. L is labour .A is a parameter measuring the

level of technology and α is a parameter between 0 and 1 that measures capital shares of
output.
 · Now MPK of cobb douglas production function.

MPK=αA L ∕ K 1-α

· The real rental price equillibriate MPk so we can write

R ∕ P =αA( L ∕ K)1-ᵅ

· This expression identifies the variables that determine the real rental price.

· The lower the stock of capital, the higher the real rental price of capital.

· The better the technology, the higher the real rental price of capital.

· The greater the amount of labour employed, higher the rental price

The cost of capital:

· The cost of owning capital is more complex for each period of time that it rent out a unit
of capital, the rental firms bear three costs.

· Interest on the loan iPK.

· When the rental firm is renting out capital, the price of capital can change.the cost of the
loss or gain is - PK.

· Depreciation cost PK.

Determinants of investment:

· The firms decision regarding investment ( To increase or decrease capital )depends upon
whether owning and renting capital is profitable or not.

· The rental firm makes profit if the marginal productivity of capital is greater then the cost
of capital.It incurs loss if the MPK is less then its cost.

Taxes and investment:

Corporate tax:

· If the law use definition, rental price minus cost of capital then the tax does not affect
investment.

· if the rental price of capital exceeded the cost of capital it will be rational for firm to
invest.
 · Firm disinvest if capital cost exceeds rental price.

Investment tax credit:

· It reduces a firm taxes by certain amount for each dollar it spends on capital.

· Hence the investment tax credit effectively reduces prices of capital.

· Which increases the profit rate and the incentives to invest.

Tobin′q and stock market:

· q =Market value of installed capital \Replacement cost of installed capital.

· The numerator of tobin q is the value of economy capital as determined by stock market.
The denominator is the price of that capital if it were purchased today.

· Tobin reasoned that net investment should depend upon whether q > 1, Buy more capital
to raise market value of firm. q < 1, do not replace capital as it tears out.

Relationship between tobin’q and neo-classical theory:

· The stock market value of capital depends on current and expected future profit of
capital.

· If MPK > cost of capital then profit rate is which drives up the stock market value of the
firm which implies the high value of q.

· If MPK < cost of capital then firms are incurring loses so stock market value falls and q is
low.

Financial constraints:

· Neo-classical theory assumes firms can borrow to buy capital whenever doing so is
profitable.

· But some firms face financial constraints:Limit on the account they can borrow.

· A recession reduces current profit.If future profits expected to be high,it might

worthwhile to continue to invest.

· But if the firm faces financing constraints, ht be the firm might be unable to obtain funds
due to current profits being low.