Discuss the Neoclassical Framework as It Relates to Decision Making

Question

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The Answer is a. (from Macro Finance Insight 6.1):
which yields

P imes \mathrm{MPK}= ext { rental cost of capital or } r

Here,

M P K

can be defined as the increment to perpetual cash flow from an increase in one unit of capital today. Investment as

\Delta K

, and assuming a perpetually level cash flow that can increase as a result of in capital. Thus we have:

\mathrm{NPV}=-\Delta K+\sum_{l}^{\infty} \frac{C F(K)_{i}}{(1+r)^{i}}=-\Delta K+\frac{C F(K)}{r}

To maximize, with respect to

\mathrm{K}

, we set

\Delta(\mathrm{NVP}) / \Delta K=0

which yields

0=-1+[\Delta \mathrm{CF}(K) / \Delta K] / r

b. There are really two issues (questions) here. Firstly, is the model relevant to all sectors in China? Secondly, if it is relevant are the costs and returns market based or are they distorted due to some form of financial repression (non-market controls in financial markets)? For the first question, those sectors which are non-government (private companies and entrepreneurs) which make up about 2/3 of all investment probably do use such a model. The second question though relates to the complex structure of China's financial markets, which remain segmented between favored borrowers (often with government ties) and non-favored borrowers. The latter use a cost of capital that is artificially high, the former a cost of capital that is artificially low.
c. Investment yields value in the future. Since such a large part of the economy is devoted to investment, we want to be sure that society's scarce resources (savings) are not being wasted.

Discuss the Neoclassical Framework as It Relates to Decision Making

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Discuss the Neoclassical Framework as It Relates to Decision Making

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