Question

4. A firm has the option of pursuing investment projects with the following monetary outlays and rates or return to capital, RORX, listed below: Project 110 50 30 150 50 200 Monetary outlay ROR 7% 3% 9% 6% 4.5% 8% 5% 8% 4% 10% 7% 5.5% ROR, after demand increase a) Graphically derive the investment demand curve for this firm. Explain how your derived this demand curve. b) Now assume that an increase in total economic activity increases the demand for this firms'output. As a result of that increase in demand the ROR, for all 6 investment projects increases by 1%. Show graphically and explain how this affects this firm's demand investment demand curve.

Answer 1

Answer a)

Graphical representation of the investment demand curve for this firm is plotted below.

This investment demand curve shows the quantity of investment demanded at each ROR_K. At ROR_K of 9%, the level of Monetary outlay is 30 at point A. At a lower ROR_K of 8%, the investment demand curve shows that the quantity of investment demanded will rise to 200 at point B. A reduction in the ROR_K thus causes a movement along the investment demand curve.

RORK Investment Demand Curve monetary Outlay 150

Answer b)

Now that an increase in total economic activity increases the demand for this firms' output, the ROR_K increases by 1% for all 6 investment projects, hence the firm's investment demand curve shifted rightward as shown in below graph.

RORK 30 150 Monetary Outlay