Answer to Question #50099 in Finance for abdulla sabit

Question

What do you understand by investment function?Explain the factors that influence the level of investment in the economy.

Answer 1

The investment function is a summary of the variables that influence the levels of aggregate investments. It can be formalized as follows:
I=f(r,ΔY,q)
where r is the real interest rate, Y the GDP and q is Tobin's q.
The reason for investment being inversely related to the interest rate is simply because the interest rate is a measure of the opportunity cost of those resources. If the resources instead of financing the investment could be invested in financial assets, there is an opportunity cost of (1+r), where r is the interest rate. This implies higher investment spending with a lower interest rate. When GDP increases, the output and the capacity utilization increases. This results in an increase of capital investment.