| Abstract: | This paper develops a theoretical investment equation for the firm which explicitly includes the relationship between investment and the price of energy. Using intertemporal comparative statics, we investigate how economic conditions affect that relationship. In a two-period model, the net present value of the firm's cash inflows is maximized subject to constraints. The resulting investment equation for the firm is summed over all firms to produce an aggregate investment equation. By assuming that aggregate shocks do not affect every firm simultaneously, we could investigate the effects of varying economic conditions on the relationship under study. We find that energy price increases will retard aggregate real investment. Also, this restraining impact will be greatest during boom periods and least during recessions. Further, the impact of an energy price increase on aggregate investment diminishes as the level of energy prices increases. We show that simple OLS techniques are not appropriate for empirical estimation of the relationship between aggregate investment and energy price; they could produce inconsistent results depending on the time period studied because of the business cycle effects. A survey of corporations along product lines would be useful to test for such non-linearity. |
