Page 88 - Macroeconomics. book docx_Neat

The simplest investment function assumes that investment depends mainly on the

interest rate. When the interest rate is low, firms borrow more and invest more. When

the interest rate is high, investment decreases.

Simple form:

I = a - b r

Where:

I = Investment

a = Autonomous investment

b = Sensitivity of investment to interest rate

r = Interest rate

⚫ Numerical Example (Step by Step)
Assume:

Autonomous investment (a) = 200

Sensitivity coefficient (b) = 10

Interest rate (r) = 5%

Investment = 200 - (10 × 5) = 200 - 50 = 150

This means firms invest 150 units when the interest rate is 5%.

⚫ Change in Interest Rate Example

If the interest rate increases from 5% to 8%:

Investment = 200 - (10 × 8) = 200 - 80 = 120

Result: Investment decreases from 150 to 120.

Conclusion: Higher interest rates reduce investment.

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