any given period, a firm can determine its optimal stock of capital as
shown in Figure 15-2. But if the economic environment changes either
because of a change in technology, a change in the firm’s market price, or
a change in interest rates, the firm’s optimal capital stock will also change.
In order for the firm to adjust its capital stock appropriately, it needs to
carry out investment. A positive flow of investment—buying new capital—
leads to an increase in the capital stock; a negative flow of investment—
selling existing capital—leads to a decline in the capital stock.
How do we get from the firm’s optimal capital stock to its demand for
investment? For any period, the firm’s investment demand is the change
the firm’s optimal capital stock, which in turn is determined by changes in
the economic environment. To illustrate, continue with our example of a
graphic-design firm with an optimal capital stock of 100 specialized
computers at the beginning of 2019. During the year 2019, suppose
interest rates decline, thereby increasing the firm’s optimal capital stock
to 110 computers. For the year 2019, the firm would therefore have a
demand for investment equal to the change in this optimal stock—in this
case, 10 computers. After the firm carries out this investment (after it buys
10 new computers), it would then possess its (new) optimal capital stock.
In any given period, the profit-maximizing firm’s investment demand is given by the change
the firm’s optimal capital stock.Emphasis on the Interest Rate
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