Question

How will planned investment spending change as the following events occur? a. The interest rate falls as a result of Federal Reserve policy. b. The U.S. Environmental Protection Agency decrees that corporations must upgrade or replace their machinery in order to reduce their emissions of sulfur dioxide. c. Baby boomers begin to retire in large numbers and reduce their savings, resulting in higher interest rates.

Short answer

Answer: A) A decrease in interest rates due to Federal Reserve policy lowers borrowing costs for businesses, encouraging them to increase their planned investment spending. B) EPA regulations requiring upgrades or replacements of machinery to reduce emissions will likely lead to an increase in planned investment spending as companies invest in compliance. C) Higher interest rates resulting from retiring baby boomers and decreased savings can lead to a decrease in planned investment spending as businesses face higher borrowing costs.

Step-by-step solution

Event A: Interest rate falls due to Federal Reserve policy

: The Federal Reserve is responsible for setting the interest rates, which will have an impact on businesses' borrowing costs and, consequently, their investment spending. In this event, interest rates are falling as a result of the Federal Reserve's policy action.

Determine the impact of lower interest rates on business borrowing

: When interest rates fall, borrowing costs for businesses decrease, making it cheaper for them to finance their investment projects. This can encourage businesses to increase their planned investment spending on projects such as expansions, new machinery, or research and development.

Evaluate the overall effect on planned investment spending

: Given that the lower interest rates make borrowing cheaper for businesses, it's reasonable to expect that planned investment spending will increase in response to this event.

Event B: EPA decree to upgrade or replace machinery to reduce emissions

: In this event, the U.S. Environmental Protection Agency (EPA) is enforcing regulations that require corporations to upgrade or replace their machinery to reduce sulfur dioxide emissions.

Assess the implications of a government regulation

: The EPA's decree essentially requires companies to invest in new equipment or upgrade their current machinery to be in compliance with the new regulations. This implies that businesses will likely have to allocate additional resources for planned investment spending to meet these regulations.

Estimate the effect on planned investment spending

: As corporations are required to make investments to comply with the EPA regulations, we can expect an increase in planned investment spending due to this event.

Event C: Baby boomers retire, and savings decrease, leading to higher interest rates

: As baby boomers begin to retire, their savings decrease, which can lead to an increase in interest rates. This event will have an impact on planned investment spending.

Examine the relationship between savings and interest rates

: When savings decrease, the supply of loanable funds shrinks, which can lead to higher interest rates. As a result, businesses might face higher borrowing costs.

Assess the effect of higher interest rates on planned investment spending

: Higher interest rates make borrowing more expensive for businesses, which can lead them to reduce their planned investment spending on projects as the cost of financing becomes less attractive.

Evaluate the overall impact on planned investment spending

: Given the increase in interest rates due to the retirement of baby boomers and reduced savings, it's reasonable to anticipate that planned investment spending will decrease in response to this event.