Question

Assuming investment is autonomous, draw an investment function with income on the horizontal axis. Show how the function shifts if: a. The interest rate falls. b. An investment tax credit is repealed by Congress. c. A new president is expected to be a strong advocate of pro-business policies. d. There is a great deal of excess capacity in the cconomy.

Short answer

Answer: a) The investment function will shift upward when the interest rate falls, b) It will shift downward when an investment tax credit is repealed, c) It will shift upward in anticipation of a pro-business president, and d) It will shift downward due to excess capacity in the economy.

Step-by-step solution

Drawing the basic Investment Function

First, let's draw the basic investment function with income on the horizontal axis. In this basic function, investment is autonomous, which means it does not depend on income. As a result, the graph will show a horizontal line parallel to the income axis.

Analyzing the effect of a falling interest rate

When the interest rate falls, borrowing money becomes less costly for firms, which encourages them to invest more. This leads to an increase in the investment level, shifting the investment function upward. In the graph, the horizontal line representing the investment function will shift up.

Analyzing the effect of repealing an investment tax credit

When Congress repeals an investment tax credit, the cost of investing goes up for companies as they lose the tax benefits. This causes a decrease in investment, resulting in the investment function shifting downward. In the graph, the horizontal line representing the investment function will shift down.

Analyzing the effect of a pro-business president

If a new president is expected to promote pro-business policies, companies will anticipate a favorable investment environment due to a possible reduction in regulations or new incentives. This leads to an increase in the investment level, causing the investment function to shift upward. In the graph, the horizontal line representing the investment function will shift up.

Analyzing the effect of excess capacity in the economy

When there is a great deal of excess capacity in the economy, firms have underutilized resources and are more hesitant to invest in new projects. This results in a decrease in the investment level, shifting the investment function downward. In the graph, the horizontal line representing the investment function will shift down. In conclusion, the investment function will shift in the following ways in each of the scenarios: a. Upward when the interest rate falls. b. Downward when an investment tax credit is repealed. c. Upward in anticipation of a pro-business president. d. Downward due to excess capacity in the economy.