[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

the firm could have obtained if, instead of making an investment, it had simply
decided to lend the funds to some other firm.
The investment function gives the level of (real) investment at each value
of the real rate of interest. The investment function slopes downward to the right;
investment increases as the real interest rate decreases. This is depicted in Figure
24.7, which shows the real interest rate on the vertical axis and the level of real investment
on the horizontal axis.
Wrap-Up
SAVING VERSUS INVESTMENT
What we often call investing (putting money into a mutual fund, purchasing
shares in the stock market) is actually saving—setting aside part of our income
rather than spending it. These funds are then made available through the financial
system to individuals and firms who wish to purchase capital goods such as plant and
equipment or build new office buildings, shopping malls, or homes.
Investment refers to such additions to the physical stock of capital in the economy.
As the real interest rate rises, the cost of borrowing funds for these investment projects
rises. As a result, fewer projects will look profitable, fewer households will buy
a new car, and fewer homes will be constructed.
Saving may rise as households reduce consumption to take advantage of higher
rates of return on their savings. However, the evidence suggests this effect is small,
so we will often assume that saving is inelastic.
EQUILIBRIUM IN THE CAPITAL MARKET
The equilibrium real interest rate is the rate at which saving and investment balance,
as depicted in Figure 24.8. Panel A shows saving increasing as the real interest
rate rises, while panels B and C illustrate the case of an inelastic saving curve.
The impact of an increased demand for investment at each real interest rate is shown
in panels A and B. In panel A, both the equilibrium real rate of interest and the equilibrium
levels of saving and investment increase. Because the rise in the interest
rate induces households to save more, in the new equilibrium the quantity of investment
is able to rise. In panel B, only the equilibrium real interest rate changes as a
result of the shift in investment demand. Because saving is inelastic in panel B, the
change in the interest rate leaves saving unaffected. As a consequence, the quantity
of investment must also be unchanged (since saving and investment are equal
in equilibrium). Despite the rightward shift in the investment function, the real
interest rate increases enough to keep investment unchanged.
Panel C illustrates the effects of a shift in the saving curve. A rightward shift in
the saving curve, perhaps caused by households wishing to set aside more for
retirement, results in a fall in the equilibrium real rate of interest and a rise in
equilibrium investment.
538 ∂ CHAPTER 24 THE FULL-EMPLOYMENT MODEL