Question

In what direction will each of the following occurrences shift the investment demand curve, other things equal?

1. An increase in unused production capacity occurs.

2. Business taxes decline.

3. The cost of acquiring equipment falls.

4. Widespread pessimism arises about future business conditions and sales revenues.

5. A major new technological breakthrough creates prospects for a wide range of profitable new products.

Short answer

1. The investment demand curve will shift to the left.

2. The investment demand curve will shift to the right.

3. The investment demand curve will shift to the right.

4. The investment demand curve will shift to the left.

5. The investment demand curve will shift to the right.

Step-by-step solution

Explanation for part (a)

An increase in unused production capacity means lower demand for goods and services in the market. The existing supply is not exhausted. It will act as a depressant for investment activities because of lower profits. Firms will be reluctant to invest in new capital goods. Therefore, the investment demand curve will shift toward the left.

Explanation for part (b)

As business taxes decline, the expected profit after the taxes will increase. As the investment decision depends on the expected rate of return, the possibility of a higher rate of return will raise the investment, and its demand curve will shift to the right.

Explanation for part (c)

When the cost of acquiring equipment decreases, the average cost of the project decreases. The firm expects higher profits through increased supply. This leads to an increase in investment. Thus, the investment demand curve will shift to the right.

Explanation for part (d)

When pessimistic sentiments regarding future business conditions and sales revenue spread in the economy, the entrepreneurs become less willing to take a risk. They prefer to hoard their money instead of spending on business activities due to fear of loss in the coming time. Therefore, investment falls, and the investment demand curve shifts to the left.

Explanation for part (e)

A technological breakthrough results in higher productivity and lower cost of production. It expands the opportunities for businesses to increase their production and earn greater profits. Thus, the investment demand increases, and the demand curve shifts to the right.

As investment demand increases, the ID curve shifts to the right from ID0 to ID1 and vice versa.