1 Positive investment may not add to the firm’s capital stock if it is just enough to replace obsolete
capital. In this discussion, however, we make the simplifying assumption that all investment is
investment and thus increases the firm’s capital stock.
2 This negative relationship between the interest rate and the firm’s desired investment demand
can be given another interpretation. Instead of purchasing physical capital, the firm could instead
decide to purchase a bond that pays interest in the future. The interest rate on such a bond is the
opportunity cost the firm faces if it chooses to invest in physical capital. A higher interest rate
makes the bond purchase relatively more attractive and the investment in physical capital less
attractive, and thus it leads the firm to reduce its desired investment demand.