Theories of Fixed Investment Determination
One theory of the determination of fixed investment focuses on the discrepancy between the current quantity of the fixed capital stock and the optimal or target capital stock. The target capital stock — the level at which a firm's profits would be highest if actual fixed capital holdings equaled that level — is determined as the level at which the marginal product of capital equals the marginal cost of capital. Then the flow of net investment per unit of time is determined by balancing losses from having a less-than-optimal level of capital with the adjustment costs of installing new capital; these adjustment costs in per-unit terms may be an increasing function of the speed of installation.
Another theory of fixed investment determination is based on Tobin's q, the ratio of the market value to the acquisition cost of an additional unit of physical capital; investment is hypothesized to be an increasing function of this ratio.
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