ECON 272

Out of Class Practice Problem on Malinvestment and the Hayekian Capital Structure

Draw a Hayekian triangle and explain what it represents. 

In your explanation - discuss why capital should be seen as heterogeneous and why a part of the capital structure for good A will not necessarily be productive if used in the capital structure for good B.

Assume that interest rates have decreased.  But this decrease was not due to an increase in savings (due to a decrease in time preferences), but instead was due to an increase in the money supply by the FED.  Entrepreneurs don't know this and assume savings have increased. 

Explain what entrepreneurs will do and why - and show how this would "shift" or change the capital structure (Hayekian triangle). 

Explain why this will lead to malinvestment.