Financial Information
[A] What factors will determine if the demand for Investment by firms will remain constant?
Question : [A] What factors will determine if the demand for Investment by firms will remain constant?
If the Fed lowers interest rates, the law of demand tells us that Investment by
firms will increase if Demand [ceteris paribus]. [A] What factors will
determine if the demand for Investment by firms will remain constant? [B] What
assumption about the stability of the demand for Investment function (curve)
does the Fed have to make if it attempts to stimulate the economy during a
downturn?
investment firms
Best answer:
Answer by guenndu
This study is ready to connect the firm’s investment decisions with its financing decisions.
The cost of capital provides this fundamental connecting link. The term cost of capital may be used
interchangeably with the firm’s required rate of return, the hurdle rate, the discount rate, and the
firm’s opportunity cost of funds. This study is about the concepts behind the cost of capital, as well
as the procedures for estimating the firm’s cost of capital. For the most part, we will assume a
constant debt-to-equity mix when computing a company’s cost of capital.
The Austrians would say that the assumption that the Fed stimulates the economy with lower interest rates during a downturn is faulty. By lowering interest rates below the market clearing rate there will be an increase in the number of borrowers beyond what savings can support. This added capital investment will cause a shift in industry away from consumer goods to capital goods. As the money runs out the interest rates spike limiting investment and forcing a shift the other way back to consumer goods and capital goods. This back to the demands of the market is what causes economic downturns. (F. A. Hayek won a Nobel for that explanation of the business cycle, but the politicians decided that the Keynesian stuff was more suited to their exercise of power so that’s what gets taught in schools and implemented as policy) If the Fed lowers the interest rates further when this happens to “stimulate the economy” during the subsequent downturn, it delays the liquidation of the malinvested capital and prolongs the downturn.
For demand to remain constant as price decreases would require the demand curve to shift left or down. A shift left requires investors to be less willing to borrow money at a given price (e.g. they’ll borrow $ 100K at 5% instead of $ 1M at %5). A shift down means they’ll be less willing to pay a given price for a certain amount of money (e.g. they’ll borrow $ 100K at 4% instead of $ 100K at 5%)