Chapter 16, Problem 2FRQ

To determine

The question requires us to list and then explain the three important factors impacting planned investment spending.

Explanation of Solution

The intended investment undertaken by the firms during a given financial period is considered a planned investment in an economy.

The three factors affecting the planned investment in an economy are the following:

1. Interest rate
2. Production capacity, and
3. Expected real GDP

1. Interest rate: There is an inverse relationship between investment spending and the interest rate because the interest rate represents the costs of borrowing for a firm. A higher interest rate indicates a higher cost of borrowing which discourages the firms and reduces investment in the market. Similarly, a lower interest rate will encourage the firms to take more loans and promote their business by investing more.
2. Production capacity: If a firm expects growth in future sales and it has the insufficient production capacity to meet that growth, the firm will increase its investment spending on machinery, equipment, and human resources. In the opposite scenario, when a firm expects a fall in future sales, it will reduce its investment spending. 
3. Expected real GDP: If firms find that the expected real GDP will increase, they will increase their production capacity by increasing the level of investment spending. As the boom or higher real GDP is an indication of higher demand for goods and services and thus it reflects a higher growth in expected future sales.