 investment, its importance, and the determination of the desired capital stock. Dear students, aggregate demand for the second important component here, Pehlamne discussed here consumption or the next important component here, that is investment. Investment means purchase or construction of capital goods and addition to the inventory stocks. Capital goods includes building, equipment, and like this. So, ummei zafa karna, hiya inventory mei zafa karna, so this is called investment. What is the importance of investment? Investment is the first component of aggregate demand to consumption and the second component of investment. If you compare investment with consumption, then the total aggregate demand has a large share compared to investment. Investment is relatively less, but because of its importance, investment is relatively volatile compared to consumption. It has a lot of fluctuations. We have understood that people want to keep the consumption smooth. There are fluctuations in income, but people keep the consumption relatively stable. There are not many fluctuations in that. But there are many fluctuations in investment. In the economy, when there is a recession, there is a lot of share of investment as compared to consumption. For example, if the share of investment in aggregate demand is 1.6, but in recession, its share becomes more than 50%. So, this is its significance. Although its share is less, but since it is more volatile, when there are changes in the economy, the share of investment in those changes becomes very important. So, this is its importance. When we want to understand the business cycle, we understand that there are fluctuations in the economy. There is a recession and there is a boom and so on. So, when we want to understand the business cycle, then investment becomes very important for it. Second, its importance is that your long-run lifestyle or living standard determines that too. Because investment has a capital formation. Capital stock is added. And as a result, in your future, your output increases and that output improves your living standard. So, if you want to understand the economy in the short run, if you want to understand its fluctuations, then investment is very important for it. And if you want to understand the long-run growth, then investment is very important for it. So, first of all, despite the less investment size, why is its importance so much? And desired capital stock. So, investment is also trade-off between current and future. As we understood in the consumption, if we reduce the consumption today, then we can increase the consumption in the future. So, this is trade-off. Similarly, investment is also a trade-off. The resources available to firms, if they invest today, then how did their trade-off happen? What will happen if they invest today and allocate their resources for capital formation? So, today, they will not be able to give dividend to their shareholders. Today, they will not be able to enjoy their resources and profits. They are investing. But as a result, their production capacity will increase and their income will increase in the future. So, they will forego today's dividend so that they will get more profit tomorrow. So, in this sense, it is also a trade-off. Desired capital stock means that the kind of consumption in which we read that in the distribution of consumption, the objective of the consumer is that he wants to maximize his lifetime utility. Similarly, the objective of the firm in investment is that he wants to maximize his profits. So, for that, they will decide how much they invest today and how much they give dividend to their shareholders. Okay. Desired capital stock, what will happen? The decision will also be the same, cost-benefit. We will do an analysis that if we want to install an additional unit of capital stock, then what is the cost on it and what will be its benefit? So, the simple economic rule is that if the cost is too much and the benefit is low, then we do not work. And if the situation is reverse, if the benefit is too much and the cost is low, then we will install that unit. We have understood the basic difference between benefit and cost. If you want to install a unit today, then you will have to bear its cost today. Okay. The resources you have to allocate for that you will have to do it today. But its benefit will be in the future because that investment takes some time period, there is a lag involved, and then it becomes the capital and then it gives you production. So, you will get the benefit in the future. Okay. And the cost you will have to do it now. There will be its cost in the future too. But the benefit will be in the future. So, with the benefit of that, we are saying that the margin product of capital that we will get will be the margin product of capital for the future. Okay. In the first step, we will discuss the cost. What is the cost? For this, we are taking an example. Suppose, there is a firm who wants to purchase a new solar powered oven. Its price is $100 per cubic feet. Okay. What is its cost? Cost is of two types. One is that the resources we want to purchase where will the resources come from? There are two possibilities again. One is that the firm will borrow. If the firm will borrow, they will have to pay the interest on that borrowing amount. So, the interest will be its cost. And even if the firm is not borrowing, they have their own resources. They are using it to purchase it. So, you know, in economics, we say opportunity cost. If the firm is not using those resources for this purpose, what could have been its second use to lend it to the firm? And could have earned the interest on it? But since the firm is using it for the purpose of capital, the firm will not be able to lend it. So, we say opportunity cost. The firm who could have earned the interest had to forego the interest. So, in both cases, if the firm has its own resources, even if it is not there, we will consider its interest payment on its cost. What will we have to bear? So, the first component is that R is the real interest rate. Pk is the price of that capital unit. So, for example, as we said that its $100 price and if the interest rate is 8%, then we will multiply 8% by 100. So, this means that the firm will have to pay the bank for the purchase of that unit for $8. So, this is the cost. The second cost is its depreciation. Whatever capital unit is, when we install it, use it, and produce it, then with the passage of time, it is worn out. It gets depreciated. Its efficiency decreases and then it gets scrapped. So, every year, when we calculate its cost, we will also consider how much depreciation is going to be. So, this will be the user cost in terms of interest payment and depreciation. D is the depreciation rate. R is the real interest rate and Pk is the price of that capital unit. So, this will be the total user cost. Suppose, if the interest rate is 8%, the depreciation rate is 10%, then this means that the unit of $100 per unit will have to pay the cost of 18% annually. This can also be the cost of maintenance. But just to keep it simple, we will ignore it for the time being. So, this is a simple diagram of how the optimal level of capital stock or decide level of capital stock will be determined. It is a simple rule of economics where the marginal cost and the marginal benefit will be equal to the capital stock. The horizontal line is the user cost. Its slope is zero. Why do we assume that the interest rate is constant? The depreciation rate is constant. That's why this is a straight line at 18%. Its slope is zero. This is not changing. We are taking capital stock on the horizontal axis. On the vertical axis, we are taking the user cost and the marginal product of capital. So, the user cost is the capital stock. If it takes one unit, if it takes two units, if it takes all the units, if the interest rate is constant and the depreciation rate is constant, the user cost remains constant. That's why we have this horizontal line. But the marginal product of capital in the future is a negatively sloped line. Negatively sloped, you know, because of diminishing returns, that when additional you keep the labor constant and increase the capital, the product of the additional unit will work. And before this, we have discussed that keeping the capital fixed when we increase the labor, every additional unit of worker would reduce its product. So, the marginal product of capital in the future, it is diminishing but the user cost is constant. So, where both are intersecting at this point, this is determining the desired level of capital stock. To understand this, suppose take this 4 that if that form 4 units is installed, on 4 units, marginal product of capital is 20, user cost is 18, benefit is more, cost is less, which means that 4 units are becoming the cause of increase in total profit. So, this unit should be installed. And if you discuss 6 units, what is on 6 units is that cost is more and benefit is less, so the firm should not install 6 units. So, where will it stop? On 5th, where marginal cost and marginal benefit are both equal. So, desired capital stock is the level where marginal product of capital is equal to the user cost. And marginal product of capital we have discussed due to the it is negatively sloped and user cost according to our assumption, k-interstate is constant and the depreciation rate is constant. So, user cost is the horizontal line. So, if marginal product of capital is greater than user cost, so this will increase the profit and k will be added, additional unit of capital will be installed and vice versa. If it is less, then it will not be recommended. And the point is that where both are equal, that will determine the desired level of capital stock. This means that it is the level of capital stock where its profit is maximum. Thank you.