Question

explain briefly whether true or false:

According to the neoclassical theory of investment, expectations of a fall in the relative price of capital goods should increase investment

Answer 1

The given statement is false. Expectations of a fall in the relative price of capital goods will increase investment as per the neo classical theory. According to the theory, accumulation of capital stock depends on Marginal productivity of capital(MPK) and real rental cost of capital. Real rental cost of using capital is interest payment less nominal capital gain. Since the prices of capital goods are expected to fall, firms will lose capital gain on capital goods which leads to higher cost of using capital good. Thus investment would fall.