Graphing Exercise: Investment Demand Curve

A profit-maximizing firm will undertake any investment project that adds to its profits.  Under what conditions will a particular investment be profitable?  By comparing the additional sales revenue generated by the project over time to the project’s anticipated costs, we can find the project’s expected rate of return, r.  The investment project will be profitable if this expected rate of return exceeds the opportunity cost of the funds—the interest rate, i—used to finance the project.  For the economy as a whole, all investment projects whose real rate of return exceeds the real rate of interest will be undertaken.  That is, investment is undertaken up to the point where r = i.

Exploration: How is the demand for investment goods related to the real rate of interest?


The graph illustrates the total dollar amount of investment projects (measured in billions of dollars on the horizontal axis) whose expected rate of return is at least r (measured in percent on the vertical axis.)  For example, the graph shows that there are currently no investment projects whose expected rate of return is at least 12%, but $15 billion worth of investment projects whose rate of return is at least 6%.  To use the graph, click and drag on the blue diamond to adjust the real rate of interest; click and drag on the ID label to shift the investment demand curve.

  1. What is the total dollar value of investment projects whose rate of return is at least 8%?  How much total investment will take place if the interest rate is 8%?
    See answer here
  2. If the interest rate falls from 8% to 4%, what happens to total investment spending?
    See answer here
  3. Suppose a projected improvement in the economy increases the expected rate of return on every possible investment project by 2%.  If the interest rate is 6%, what will happen to total investment? 
    See answer here
  4. Explore on your own.  What is the general relationship between the rate of interest, the rate of return on investment, and total investment spending?
    See answer here