capital stock adjustment

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A theory of investment based on the capital–output ratio. The model assumes that firms have a target capital–output ratio. If at any time actual capital stock is less than is implied by this ratio, the firm invests so as to close part of the gap during the next period. Partial adjustment is assumed, taking account of both uncertainty and costs of adjustment. Thus if Y is output and the desired capital–output ratio is a, the target capital stock is K* = aY, and if the actual capital stock K is not equal to K* then investment is I = b(K* − K) = b(aYK), where 0 ≤ b ≤ 1. As with the accelerator model, a rise in Y increases K* and thus leads to investment.

Subjects: Economics.

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