Question

Which of the following scenarios will shift the investment demand curve right? \(L O 30.4\) Select one or more answers from the choices shown. a. Business taxes increase. b. The expected return on capital increases. c. Firms have a lot of unused production capacity. d. Firms are planning on increasing their inventories.

Short answer

Options b and d shift the investment demand curve right.

Step-by-step solution

Understanding the Investment Demand Curve

The investment demand curve represents the relationship between the quantity of investment demanded and the interest rate. Factors that increase the expected profitability of investments, such as higher expected returns or favorable economic conditions, will shift this curve to the right.

Analyzing Business Taxes Increase (Option a)

An increase in business taxes typically decreases the net profitability of investments. As a result, firms may be less inclined to invest, causing the investment demand curve to shift to the left rather than to the right.

Considering Expected Return on Capital Increase (Option b)

If the expected return on capital increases, firms anticipate higher profitability from investments. This prospect incentivizes more investment, shifting the investment demand curve to the right.

Evaluating Unused Production Capacity (Option c)

When firms have a lot of unused production capacity, they are unlikely to invest in new capital because they already have excess capacity. This situation typically does not shift the investment demand curve to the right.

Reviewing Plans to Increase Inventories (Option d)

If firms plan to increase inventories, it suggests they anticipate higher demand for their products, which can lead to increased investment in inventory. This scenario can shift the investment demand curve to the right.

Key concepts

Business Taxes

Business taxes play a crucial role in influencing a firm's investment decisions. When business taxes increase, the cost of investment rises for companies. This means that the net profitability, which is the return a business retains after all costs and taxes, diminishes. Higher taxes can reduce the incentive for businesses to invest in new projects or infrastructure since the potential gains are outweighed by the costs.
Therefore, an increase in business taxes tends to shift the investment demand curve to the left. On the contrary, lower taxes can make investments more attractive, potentially shifting the curve to the right. Understanding this relationship helps predict business behavior under different tax regimes, ultimately affecting the economy's overall investment levels.

Expected Return on Capital

The expected return on capital is a significant factor affecting investment decisions. It represents the anticipated profit from an investment compared to its cost. When firms expect higher returns, they are likely to increase their investment activities because the potential for profit is greater.
If the expected return on capital rises, businesses anticipate more favorable returns on their investments, incentivizing a greater demand for investment. This change shifts the investment demand curve to the right, as companies are willing to undertake more investment projects. This factor highlights how optimism about future returns can drive economic growth and expand market activities.

Unused Production Capacity

Unused production capacity refers to the situation when a firm has more equipment or facilities than it currently needs for its production levels. When there is a lot of unused capacity, firms are generally hesitant to invest in new machinery or facilities, as they aren’t fully utilizing what they already have.
This scenario often results in no significant shift in the investment demand curve, or at times, a leftward shift. Firms with excess capacity focus on optimizing their current resources before deciding on further investments. Therefore, a high level of unused production capacity can act as a deterrent to additional investment in the short term.

Inventory Investment

Inventory investment is a firm's approach to managing its stock of goods and products. When firms decide to increase their inventories, they are essentially investing in more stock to meet future demand.
This increase in inventory levels often indicates that businesses expect higher sales, prompting a shift in the investment demand curve to the right. A decision to boost inventories shows confidence in future economic conditions and consumer demand, motivating further investment in production capacity and resources. Inventory investments can thus be a positive sign, reflecting a proactive stance towards anticipated market growth.